Final answer:
The rate of return on a 10% coupon bond purchased at $1,100 and sold after two years for $980, taking into account the coupon payments received, results in an approximate annual rate of return of ~9.09%.
Step-by-step explanation:
The question involves calculating the rate of return on a bond investment. When an investor purchases a bond above its face value, such as at $1,100, and sells it before maturity because interest rates rise, the sale price might be less than the purchase price. In this scenario, the sale price after two years is $980. Additionally, the investor would have received coupon payments based on the 10% coupon rate during the holding period.
To calculate the rate of return, we must consider both the coupon payments received and the capital loss from selling the bond at lower than the purchase price. The bond will have paid $110 per year in coupon payments (10% of $1,000 face value). Over two years, this totals $220. The overall loss on the principal is $1,100 (purchase price) - $980 (sale price) = $120. Therefore, the total return over two years is $220 (coupons) - $120 (loss) = $100.
To calculate the annual rate of return, we use the initial investment of $1,100 as the denominator, and the total return over two years as the numerator. The calculation is $100/$1,100 = ~9.09%. This is an approximation because it is not compounded annually. However, it gives a basic idea of the annual rate of return, before considering more complex factors like compounding.