Question

What is the rate of return on a bond with a coupon of $38 payable in one year that was purchased for $950 and sold one year later for $931?

A. 2%
B. 4%
C. 3%
D. 7%

Answer 1

The rate of return on the bond is 2%. This is found by calculating the total return ($19) from the coupon payment and the sale price of the bond, then dividing it by the initial investment ($950), and converting it to a percentage.

Step-by-step explanation:

To calculate the rate of return on a bond, we account for two things: the coupon payments and any capital gains or losses on the sale of the bond. In this scenario, you have a $38 coupon payable in a year and the bond is purchased for $950 and then sold for $931.

The total money received from the bond is the sum of the coupon payment and the sale price: $38 (coupon) + $931 (sale price) = $969. The initial investment was $950, so we calculate the return by subtracting the initial investment from the money received:

$969 (total money received) - $950 (initial investment) = $19 (total return)
We then divide the total return by the initial investment and convert it into a percentage to find the rate of return:

$19 (total return) / $950 (initial investment) = 0.02 (rate of return in decimal form)
0.02 × 100 = 2% (rate of return as a percentage)

Therefore, the rate of return on the bond is 2%, which corresponds to choice A.