On January 1, 2006 Joan James purchased five 7.2% semi-annual bonds with twenty years to maturity. The maturity value of each bond is $1000 and it makes its coupon payments on June 30 and December 31 of each year. At the time of the purchase, the bonds’ yield to maturity was 7.8%. On 1/1/2012, Joan sells the bonds, which are now yielding 4.6%.
Answer the following questions:
What is the purchase price of the bonds?
What is the sell price of the bonds?
What nominal rate of return did Joan receive on this investment i.e., what is her holding period yield? Hint: you must consider the time value of money when answering this question.
When Joan purchased the bond, its yield to maturity was 7.8%. Why is her holding period yield different than 7.8%?
If the average inflation rate over this holding period was 3.1%, what was Joan’s real rate of return using the Fisher equation 5.2 in your text1?
1 Equation 5.2: 1 + R = (1+r) (1+h) where R = nominal rate of return, r = real rate of return, and h = the inflation rate.