Then a coupon bond is issued, the coupon is generally set at a level that causes the bond's market price to equal its par value, If a lower coupon tere set, investors would not be willing to pay $1,000 for the bond, but if a higher coupon were set, investors would bid its price up over $1,000. nvestment bankers can judge the coupon rate that will cause a bond to sell at its $1,000 par value. A bond that has just been issued is known as new issue. Once a bond has been issued, it is known as an outstanding bond, or a seasoned issue. Newly issued bonds usually sell at prices close to par, but the prices of outstanding bonds can vary more or less than par. Coupon payments are constant (excluding floating-rate bonds); so when economic conditions change, a bond with a $70 coupon that sold at its $1,000 par value when it was issued will sell for more or less than $1,000 thereafter. For any given year, the capital gains yield is calculated as a bond's annual change in price divided by the beginning-of-year price. For example, assuming that market interest rates remain constant at 7%, suppose a bond was selling for $1,000 at the beginning of the year and $1,075 at the end of the year. 1ts caplital gains yield for the year would be $75/$1,000 or 7.5%. Note: If the bond was selling at a premium, its price would decrease over time. Then the capital gains yield would be negative, but it would be offset by a high current yield. A bond's total return is equal to the current yeld plus the capital gains vield. In the absence of defalt risk and assuming market equinbrium, the total retum is also equal to YTM and the market interest rate, which in our example is 7%. Consider the folloming scenation 1. The price of this 7 th coupon bond trading at par wat remain at $1,000 if the market interest rate remains at 7%. Therefore, its current yield will remain at 7% and its capital oains vield will be zero each year 2. Suppose the price of the coupon bond is 5% and trades at a discount. At maturity, if must sell at par because that is the amount the company was pay its bondholders. Therefore, its price must rise over time. 3. Suppose the price of the coupon bond is 1026 and trades at a premium. At moturity, it must sell at par because that is the amount. the company will pay its bondhoiders. Therefore, its price must decline over time. In turnmary, a discount bend has a law coupon rete and o low current yield, but it has an expected capital gain each year, in contrast, the premium bond has a high current yield, but it har an expected capital loss each year. Then a coupon bond is issued, the coupon is generally set at a level that causes the bond's market price to equal its par value, If a lower coupon tere set, investors would not be willing to pay $1,000 for the bond, but if a higher coupon were set, investors would bid its price up over $1,000. nvestment bankers can judge the coupon rate that will cause a bond to sell at its $1,000 par value. A bond that has just been issued is known as new issue. Once a bond has been issued, it is known as an outstanding bond, or a seasoned issue. Newly issued bonds usually sell at prices close to par, but the prices of outstanding bonds can vary more or less than par. Coupon payments are constant (excluding floating-rate bonds); so when economic conditions change, a bond with a $70 coupon that sold at its $1,000 par value when it was issued will sell for more or less than $1,000 thereafter. For any given year, the capital gains yield is calculated as a bond's annual change in price divided by the beginning-of-year price. For example, assuming that market interest rates remain constant at 7%, suppose a bond was selling for $1,000 at the beginning of the year and $1,075 at the end of the year. 1ts caplital gains yield for the year would be $75/$1,000 or 7.5%. Note: If the bond was selling at a premium, its price would decrease over time. Then the capital gains yield would be negative, but it would be offset by a high current yield. A bond's total return is equal to the current yeld plus the capital gains vield. In the absence of defalt risk and assuming market equinbrium, the total retum is also equal to YTM and the market interest rate, which in our example is 7%. Consider the folloming scenation 1. The price of this 7 th coupon bond trading at par wat remain at $1,000 if the market interest rate remains at 7%. Therefore, its current yield will remain at 7% and its capital oains vield will be zero each year 2. Suppose the price of the coupon bond is 5% and trades at a discount. At maturity, if must sell at par because that is the amount the company was pay its bondholders. Therefore, its price must rise over time. 3. Suppose the price of the coupon bond is 1026 and trades at a premium. At moturity, it must sell at par because that is the amount. the company will pay its bondhoiders. Therefore, its price must decline over time. In turnmary, a discount bend has a law coupon rete and o low current yield, but it has an expected capital gain each year, in contrast, the premium bond has a high current yield, but it har an expected capital loss each year. In summary, a discount bond has a low coupon rate and a low current yield, but it has an expected capital gain each year. In contrast, the premium bond has a high current yield, but it has an expected capital loss each year. True or False: A bond's total return is equal to the current yield plus the capital gains yield. True False Step 2: Learn: Bond Peturns Watch the following video for an example, then answer the questions that folliow. Consider a corporate bond that was purchased last year with a face value of $1,000,8% annual coupon rate and a 14 -year maturity. At the time of purchase, the bond had an expected yield to maturity of 7%. Calculate the rate of retum that would have been earned for the past year if the bond was sold today for $1,080.40. In order to use your financial calculator to solve for the rate of return on this bond, you need to know the following information: First, you must solve for the present value of the bond: Complete the following tabie by selecting the appropriate values for N, in and PMIT. Then use vour financial calculator to soive for the present value of the bond, and complete the final row of the table. Now you have ali of the infoemation needed to catculate the rate of return that would have been earned for the post year if the bend was said today for 31,060.40 Consider a corporate bond that was purchased last year with a face value of $1,000,8% annual coupon rate and a 14 -year maturity. At the time of purchase, the bond had an expected yield to maturity of 7%. Calculate the rate of retum that would have been earned for the past year if the bond was sold today for $1,080.40. In order to use your financial calculator to solve for the rate of return on this bond, you need to know the following information: First, you must solve for the present value of the bond: Complete the following tabie by selecting the appropriate values for N, in and PMIT. Then use vour financial calculator to soive for the present value of the bond, and complete the final row of the table. Now you have ali of the infoemation needed to catculate the rate of return that would have been earned for the post year if the bend was said today for 31,060.40 Now you have all of the information needed to calculate the rate of return that would have been earned for the past year if the bond was sold today for $1,080.40: This bond is troding at a to por value. Therefore, it has an expected capital over time. According to the video, which of the folowing equations are used to calculate a bonds rate of return: Rate of Return =heBusithis Rate ofeturn =P0P1+PMTR Now you have all of the information needed to calculate the rate of return that would have been earned for the past year if the bond was sold today for $1,080.40: This bond is troding at a to por value. Therefore, it has an expected capital over time. According to the video, which of the folowing equations are used to calculate a bonds rate of return: Rate of Return =heBusintivi Rate ofeturn =P0P1+PMTR Now it's time for you to practice what you've learned. Consider a corpcojate bond that was purchased last year with a face value of $1,000,a9% annual coupon rate and a 12 -year maturity. At the time of purchase, the bond had an expected yield to maturity of 10%, Calculate the rate of retum that would have been earned for the past year if the bond was sold today for $936.21. Now it's time for you to practice what you've learned. Consider a corpcojate bond that was purchased last year with a face value of $1,000,a9% annual coupon rate and a 12 -year maturity. At the time of purchase, the bond had an expected yield to maturity of 10%, Calculate the rate of retum that would have been earned for the past year if the bond was sold today for $936.21