A 25-year maturity bond has a 9% coupon rate, paid annually. It sells today for $1,027.42. A 15-year maturity bond has a 8.5% coupon rate, also paid annually. It sells today for $1,039.5. A bond market analyst forecasts that in five years, 20-year maturity bonds will sell at yields to maturity of 10% and that 10-year maturity bonds will sell at yields of 9.5%. Because the yield curve is upward-sloping, the analyst believes that coupons will be invested in short-term securities at a rate of 8%.
1. Calculate the annual return for the 25-year maturity bond over the next five years.
2. Calculate the annual return for the 15-year maturity bond over the next five years.
3. Which bond offers the higher expected rate of return over the five-year period?
25-year maturity bond
15-year maturity bond.