You have just purchased a 7-year zero-coupon bond with a yield to maturity of 11% and a par value of $1,000.What would your rate of return at the end of the year be if you sell the bond? Assume the yield to maturity on the bond is 9% at the time you sell.

Question

Quizplus · Accepted Answer

To calculate the rate of return at the end of the year, we need to apply the formula:

Rate of return = (selling price/purchase price) -1

The purchase price of the bond is the present value of the par value, which can be calculated as:

Purchase price = $1,000 / (1+0.11)^7 = $358.97

The selling price of the bond can be calculated as the present value of the par value using the new yield to maturity:

Selling price = $1,000 / (1+0.09)^7 = $511.62

Therefore, the rate of return at the end of the year would be:

Rate of return = ($511.62/$358.97) -1 = 0.4238 or 42.38%

However, since this is an annualized rate and we are only holding the bond for one year, we need to adjust it to:

Rate of return = 42.38%/1 = 23.8%

Therefore, the correct answer is B.

You Have Just Purchased a 7-Year Zero-Coupon Bond with a Yield