Consider a 10 year bond making annual coupon payments at a rate of 8% with a face

value of $1000. The market interest rate is 8%.

a) Suppose you decide to buy the bond today and hold it for 10 years. What is the price of the

bond and your (holding period) return (in percentages) if the term structure stays flat at 8% for

the entire 10 years during which you hold the bond?

b) Suppose you decide to sell the bond at the end of year 4. If the interest rate stays at 8% for the

next two years from now (time 0) and then shifts down to 5% and stays at 5% for the remainder

of the 10 years, what price can you sell the bond at the time of transaction and what is your

(holding period) return (in percentages)?

Show all your work. Use formulas and/or financial calculator. No Excel.