Bond 1 has a 4%annual coupon rate, $1000 maturity value, n = 5 years, YTM = 4% (pays a $40 annual coupon at the end of each year for each of the 5 years and $1,000 maturity payment at the end of year 5).

Bond 2 is a zero couponbond with a $1000 maturity value, and n = 5 years; YTM= 4%. (pays no coupons; only a $1,000 maturity payment at the end of year 5)

a. For the Zero Coupon Bond 2 above,what will be your annual compound yield for your 5 year holding period if the bond is held until maturity. (Hint: PV is the price you calculated for Bond 2and FV is the bonds maturity value of $1,000 and n is the 5 year holding period; solving for i) (see formulas below).

Hint Recall: Annual Compound Yield = {[FV / PV] ^ 1/n} - 1 or

In other words {[What you have at the end of 5 Years / What You Paid] ^1/n } - 1

n = your 5-year holding period.

Annual Compound Yield for Bond 2 at End of Year 5 __________________

b. Suppose for the Coupon Bond 1 above, rates go down to 2% after you purchase the bond for the life of the bond. Thus, you have to invest each of your $40 coupon payments at a 2% rate, and hold the bond to maturity, receiving your $1,000 maturity value at the end of year 5.

What will be your annual compound yield?

Hint: Recall FV of Bond Coupons Reinvested for 5 years = Coupon Payment (FVIFA 2%, 5)

ACY = { [(FV of Coupons +Maturity Value) / (Price of Bond)] ^1/n } - 1, where n = 5 years

Annual Compound Yield for Bond 1 at the End of Year 5____________

c. Explain why you received your desired annual compound return for the 5 year holding period for Bond 2 in a., but didnt receive your desired Annual Compound Return for Bond 1 for your 5 year holding period in b.?