Question

Dmitri bought a $1,000 bond at par value with a coupon rate of 5 percent. He determines the yield by dividing the amount of interest he earns by the price.

a. How much interest would he earn in the first year and what would be the yield?

b. How much interest would he earn in the first year and what would be the yield if he had paid $950 for the bond? What would be the interest and yield if he paid $1,050?

This is not a multiple choice question, please answer both parts if you can.

Answer 1

a. Dmitri would earn $50 in interest in the first year (5% of $1,000). The yield would be 5%, calculated as $50 interest divided by $1,000 price.

b. If Dmitri paid $950 for the bond, he would still earn $50 in interest in the first year (5% of $1,000), but his yield would increase to 5.26%, calculated as $50 interest divided by $950 price. If he paid $1,050 for the bond, he would also earn $50 in interest in the first year (5% of $1,000), but his yield would decrease to 4.76%, calculated as $50 interest divided by $1,050 price.