A 7.25 percent coupon bond with 25 years left to maturity is priced to offer a 7 percent yield to maturity. You believe that in one year, the yield to maturity will be 7.15 percent. If this occurs, what would be the total return of the bond in percent? (Assume semiannual interest payments and $1,000 par value.)

Question

Quizplus · Accepted Answer

The total return of the bond includes both the interest payments received and the capital gain or loss on the bond. Since the bond's coupon rate is higher than its current yield to maturity, it is priced at a premium. If the yield to maturity increases to 7.15% as expected, the price of the bond will decrease because bond prices move inversely to yields. However, the investor will still receive the coupon payments, which are higher than the current yield. The combination of the interest income and the price decrease will result in a total return that is positive but less than the coupon rate, making 5.3 percent a reasonable estimate given the scenario.

A 725 Percent Coupon Bond with 25 Years Left to Maturity