Consider a 3-year coupon bond with a face value of $1,000 and a coupon rate of 10 percent. Mr. Smith purchased this bond at par (i.e., he paid Pt = $1,000) when it was newly issued. The market interest rate at the time the coupon bond was issued was 10 percent. One year from the time of the bond’s issue, he decides to sell the bond, i.e., the holding period is one year. At that time, the market interest rate has risen to 15 percent.
Set up the equation you will need to solve to find the price that Mr. Smith will obtain when he sells the bond, Pt+1. You do not have to solve for the actual price he gets.
Pt+1 will be greater than Pt. Is this statement TRUE, FALSE, or UNCERTAIN? Circle the right answer. Explain your answer below in no more than one sentence.
The rate of return will be less than the current yield of 10 percent. Is this statement TRUE, FALSE, or UNCERTAIN? Circle the right answer. Explain your answer below in no more than one sentence.
If Mr. Smith held the bond till maturity, what would his rate of return be? Why?