Question

) Consider a 3-year, $1000 par value bond with zero coupons. The yield to maturity today is 10%. We plan to buy this bond right now (t=0), and sell it a year later (t=1). If the yield to maturity decreases to 8% after we buy this bond, and if we wait until time t=1 to sell this bond, what would be our annualized holding period return? (rounded to 2 decimals) a) -5.36% b) 4.11% c) 5.66% d) 14.11%

Answer 1

d) 14.11%

Step-by-step explanation:

First, find the price of the bond today (t=0);

You can compute this using a financial calculator with the following inputs;

FV = 1,000

N= 3

PMT = 0

I/Y = 10%

then CPT PV = $751.32

Next, find the price of the bond a year later (t=1);

FV = 1,000

N= 2 (there are 2 years left to maturity at this point)

PMT = 0

I/Y = 8%

then CPT PV = $857.34

Annualized holding period return (Ann. HPR) =
`[((P1+Income))/(P0) ]^(1/t) -1`

P1 = New price

P0 = Initial price

Income = 0 (since it is a zero-coupon bond)

Ann.HPR =
`[(857.34)/(751.32)]^(1) -1\\ \\ =0.1411`

As a percentage , it becomes 14.11%