Final answer:
To calculate the rate of return on both bonds, consider the interest payments and stable prices due to constant yield to maturity. The 6.0% bond returns 6.0%, and the 8.0% bond returns 8.0%, as neither bond's price changes. Yield to maturity, interest payments, and total return are key in these calculations.
Step-by-step explanation:
The rate of return on each bond can be determined by accounting for the interest payments and the price change of the bonds, assuming that both bonds have a yield to maturity of 7.0% next year as well. For the bond with a 6.0% coupon rate, if the bond is still at the same yield to maturity the following year, the price would remain the same, and the rate of return would simply be the coupon payment, which translates to a rate of return of 6.0%. However, the bond with an 8.0% coupon rate will also pay the annual interest, and the rate of return would also be 8.0% for the similar reasoning, since the price of the bond does not change due to the constant yield to maturity.
Yield to maturity (YTM) is crucial to consider as it reflects the total return expected on a bond if held until it matures. This can include interest payments from the coupon rate and potential capital gains or losses due to price fluctuations. If an investor bought the 8% bond at a discounted price of $964, because the YTM is at 7%, and by the end of the year, they receive the face value of $1,000 plus the $80 interest, the return in this case would be higher. This scenario highlights the importance of both the coupon rate and the changing bond prices for calculating the total return.