Question

A two-year bond with par value $1,000 making annual coupon payments of $80 is priced at $1,000.What will be the realized compound return if the one-year interest rate next year turns out to be 6%?

Answer 1

10%

Step-by-step explanation:

Calculation to determine what will be the realized compound

First step is to calculate the new price

Using this formula

New price of the bond = PV of the final coupon payment + PV of the maturity amount.

Let plug in the formula

New price of the bond=80/1+r+1,000/1+r

Where,

r represent the yield to maturity

Second step is to Substitute 0.06 for r in the above equation

New price of the bond =80/1+0.06+1000/1+0.06

New price of the bond=1080/1.06

New price of the bond=1018.87

Now let Calculate the rate of return of the bond

Using this formula

Rate of return=Coupon+New price-old price/Initial price

Let plug in the formula

Rate of return=$80+1018.87-1000/1000

Rate of return=98.87/1000

Rate of return=0.09887*100

Rate of return= 9.887%

Rate of return=10% Appropriately

Therefore what will be the realized compound is 10%