Suppose you are holding a 5 percent coupon bond maturing in one year with a yield to maturity of 15 percent. If the interest rate on one-year bonds rises from 15 percent to 20 percent over the course of the year,what is the yearly return on the bond you are holding?
A)5 percent
B)10 percent
C)15 percent
D)20 percent

Question

Quizplus · Accepted Answer

The bond has a fixed coupon rate of 5 percent, regardless of changes in interest rates. However, the yield to maturity and the one-year interest rate have increased from 15 percent to 20 percent. As a result, the bond's price would have decreased over the year, leading to a capital loss. The total return on the bond would be the sum of coupon interest and capital gain/loss. In this case, the capital loss from the increase in interest rates offset the coupon interest, resulting in a total return of 15 percent (yield to maturity).

Suppose You Are Holding a 5 Percent Coupon Bond Maturing