Question
a) You purchased a 3 year, 10% coupon bond at $950. Two years later (after receiving two coupon payments), you decided to sell it for
a) You purchased a 3 year, 10% coupon bond at $950. Two years later (after receiving two coupon payments), you decided to sell it for $975. After the sales, you wonder what the annual rate of return of the investment was. Please calculate the annual rate of return.
b) Going back to a), your friend tells you that you should have kept the bond till its maturity, instead of selling it at $975 in year 2. Calculate the yield to maturity of the bond to check.
c) You are considering the purchase of a 1-year, zero-coupon bond. But the bond issuing company has run into financial trouble recently and now there is 20% chance that the company will default on its debt/bond payments next year. If the market interest rate of risky bonds like this is 10%, how much would you pay for this bond?
d) What is the maximum price you should pay for the bond in c) when its default probability is 10%, not 20%?
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