Reading 65: Yield Measures, Spot Rates, and Forward Rates L interest, payments, investing, par, 2010

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LOS a: Explain the sources of return from investing in a bond.

A bond has a par value of $1,000, a time to maturity of 20 years, a coupon rate of 10% with interest paid annually, a current price of $850, and a yield to maturity (YTM) of 12%. If the interest payments are reinvested at 10%, the realized compounded yield on this bond is:

A) 10.00%.

B) 10.9%.

C) 12.0%.

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The realized yield would have to be between the reinvested rate of 10% and the yield to maturity of 12%.

 

honeycfa

A 30-year, 12% bond that pays interest annually is discounted priced to yield 14%. However, interest payments will be invested at 12%. The realized compound yield on this bond must be:

A) greater than 14.0%.

B) between 12.0% and 14.0%.

C) 12.0%.

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Since you are reinvesting the current income at 12%, you will have a return of at least 12%.  And since the bond is priced to yield 14%, you will earn no more than 14%.

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If an investor holds a bond for a period less than the life of the bond, the rate of return the investor can expect to earn is called:

A) approximate yield.

B) expected return, or horizon return.

C) bond equivalent yield.

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The horizon return is the total return of a given horizon such as 5 years on a ten year bond.

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An investor purchased a 10-year zero-coupon bond with a yield to maturity of 10% and a par value of $1,000. What would her rate of return be at the end of the year if she sells the bond? Assume the yield to maturity on the bond is 9% at the time it is sold and annual compounding periods are used.

A) 16.00%.

B) 19.42%.

C) 15.00%.

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Purchase price: I = 10; N = 10; PMT = 0; FV = 1,000; CPT → PV = 385.54

Selling price: I = 9; N = 9; PMT = 0; FV = 1,000; CPT → PV = 460.43

% Return = (460.43 ? 385.54) / 385.54 × 100 = 19.42%

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A 6-year annual interest coupon bond was purchased one year ago. The coupon rate is 10% and par value is $1,000. At the time the bond was bought, the yield to maturity (YTM) was 8%. If the bond is sold after receiving the first interest payment and the bond's yield to maturity had changed to 7%, the annual total rate of return on holding the bond for that year would have been:

A) 7.00%.

B) 8.00%.

C) 11.95%.

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Price 1 year ago N = 6, PMT = 100, FV = 1,000, I = 8, Compute PV = 1,092

Price now N = 5, PMT = 100, FV = 1,000, I = 7, Compute PV = 1,123

% Return = (1,123.00 + 100 ? 1,092.46)/1,092.46 x 100 = 11.95%

honeycfa

An investor purchased a 6-year annual interest coupon bond one year ago. The coupon interest rate was 10% and the par value was $1,000. At the time he purchased the bond, the yield to maturity was 8%. If he sold the bond after receiving the first interest payment and the yield to maturity continued to be 8%, his annual total rate of return on holding the bond for that year would have been:

A) 7.82%.

B) 9.95%.

C) 8.00%.

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Purchase price N = 6, PMT = 100, FV = 1,000, I = 8

compute PV = 1,092.46

Sale price N = 5, PMT = 100, FV = 1,000, I = 8

compute PV = 1,079.85

% return = [(1,079.85 - 1,092.46 + 100) / 1,092.46] x 100 = 8%

honeycfa

A bond is selling at a discount relative to its par value. Which of the following relationships holds?

A) coupon rate < current yield < yield to maturity.

B) yield to maturity < coupon rate < current yield.

C) current yield < coupon rate < yield to maturity.

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When a bond is selling at a discount, it means that the bond has a larger YTM (discount rate that will equate the PV of the bond's cash flows to its current price) than its current yield (coupon payment/current market bond price) and coupon payment.