A 2-year maturity bond with face value of $1,000 makes annual coupon payments of $98 and is selling at

A 2-year maturity bond with face value of $1,000 makes annual coupon payments of $98 and is selling at face value. What will be the rate of return on the bond if its yield to maturity at the end of the year is (Do not round intermediate calculations. Round your answers to 2 decimal places.)

		Rate of Return
a.	6%	%
b.	9.8%	%
c.	11.8%	%

rev: 05_11_2012


Explanation:

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the actual calculations.

The price of the bond at the end of the year depends on the interest rate at that time. With 1 year until maturity, the bond price will be $1,098/(1 + r).

a.

Price = $1,098/1.06 = $1,035.85

Rate of return = [$98 + ($1,035.85 − $1,000)]/$1,000 = 0.1338 = 13.38%

b.

Price = $1,098/1.098 = $1,000

Rate of return = [$98 + ($1,000 − $1,000)]/$1,000 = 0.0980 = 9.80%

c.

Price = $1,098/1.118 = $982.11

Rate of return = [$98 + ($982.11 − $1,000)]/$1,000 = 0.0801 = 8.01%