Paul is considering the purchase of a 6 percent (coupon rate), 8-year bond that

Question

Paul is considering the purchase of a 6 percent (coupon rate), 8-year bond that is presently priced to yield 10 percent (i.e. market interest rate is 10 percent). Based on extensive analysis of market interest rates, he thinks rates will fall so that at the end of this year the market yield of this issue will drop to 7 percent. If his expectations are correct, what kind of realized return will Paul earn by purchasing the bond today and selling the bond at the end of the year? (Assuming annual interest payments)

Explanation / Answer

FV=1000

PMT=60

N=8

1/Y=10

CLICK CPT

THEN PRESS PV=885 IS THE CURRENT BOND PRICE

now if the yield is 7% after one year

FV=1000

PMT=60

N=7

1/Y=7

CLICK CPT

THEN PRESS PV=946 IS THE one year after BOND PRICE

realized returns = (946/885)-1=6.89%

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