Consider a coupon bond with coupon rate 5 percent and a face value of $1000 and a maturity date of January 1, 2020.
A. Suppose that on January 1, 2010, when the market’s yield to maturity on this bond is 5 percent per year, you purchase the bond at price P. What will P be?
B. Now suppose that on January1, 2011, the market’s yield to maturity on this bond is 4 percent per year. What will the new price, ? (Hint: what is the bond’s maturity now?)
C. What is the annual rate of return that you would earn by holding this coupon bond from January 1, 2010 through January 1, 2011?
D. Suppose that on January 1, 2011, the market’s yield to maturity on this bond is 6 percent instead. Without redoing your calculations, explain whether your rate of return is higher or lower than in part C.