You are planning to buy a corporate bond with a seven-year maturity that pays 7 percent coupon interest. The bond is priced at $108,500 per $100,000 par value. You expect to sell the bond in two years when a similar-risk five-year bond is priced to yield 7.2 percent annually to maturity.

Required:

Assuming that you can reinvest all cash flows at an 8 percent annual rate (4 percent semi-annually), calculate your expected total return over the two-year holding period. Show all calculations.

b) What is the duration of a bond with a par value of $10,000 that has a coupon rate of 3.5 percent annually and a final maturity of two years? Assume that the required rate of return is 4 percent compounded semi-annually. Show all calculations.

c) What is the duration of a two-year zero-coupon bond that pays $10,000 at maturity and is priced to yield 4 percent with semi-annual compounding?

d) Why do the durations differ?