What will be the rate of return in Example 16.6 if the manager forecasts that in two years

the yield on 18-year bonds will be 10% and the reinvestment rate for coupons will be 8%?

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Example 16.6 Horizon Analysis A 20-year maturity bond with a 10% coupon rate (paid annually) currently sells at a yield to maturity of 9%. A portfolio manager with a 2-year horizon needs to forecast the total return on the bond over the coming two years. In two years, the bond will have an 18-year maturity. The analyst forecasts that two years from now, 18-year bonds will sell at yields to maturity of 8%, and that coupon payments can be reinvested in short-term securities over the coming two years at a rate of 7%. To calculate the 2-year return on the bond, the analyst would perform the following calculations: 1. Current price = $100 x Annuity factor(9%, 20 years) +$1,000 x PV factor (9%, 20 years) = $1,091.29 2. Forecast price = $100 x Annuity factor(8%, 18 years) +$1,000 x PV factor(8%, 18 years) = $1,187.44 3. The future value of reinvested coupons = ($100 x 1.07)+ $100 = $207 4. The 2-year return $207+ ($1,187.44 $1,091.29)=0.278, or 27.8% $1,091.29 The annualized rate of return over the 2-year period would then be 1.2781/2-1 = 0.13, or 13%.