Answer the following question regarding the price of a five percent coupon bond with the face value of $1000, which matures in three years from today. Coupon is paid annually at the end of the year. Your investment plan is to purchase the coupon bond today and hold it to the maturity.

1. a) Assuming the market price of bond is $1000, what would be the yield to maturity?

2. b) Suppose that you can reinvest your coupon at the annual rate of return of 3%. What is your effective

   annual rate of return on the bond investment. Why is your effective rate of return different from the yield to maturity, if it is different? Under what circumstance, effective rate of return is equal to yield to maturity?

3. c) Now suppose the market price of bond drops to $900 right after the purchase. Would you expect higher or lower effective rate of return on the bond investment than the yield to maturity you compute in a? Explain why.