Assume that you purchase a five-year, $1,000 par value bond, with a 6 percent coupon and a yield of 7 percent. Immediately after you purchase the bond, yields rise to 8 percent and remain at that level to maturity. Calculate the realized horizon yield if you hold the bond to maturity. Interest is paid annually.
A) 6.0 percent
B) 7.11 percent
C) 8.0 percent
D) 15.25 percent
E) 8.18 percent

Question

Quizplus · Accepted Answer

The realized horizon yield is the actual return on the bond if you hold it to maturity, taking into account both the coupon payments and the price change due to the change in yields.

First, let's calculate the price of the bond at the time of purchase:

PV = 60 / (1+0.07)^1 + 60 / (1+0.07)^2 + 60 / (1+0.07)^3 + 60 / (1+0.07)^4 + 1060 / (1+0.07)^5
PV = 1033.02

So you paid $1,033.02 for the bond.

Next, let's calculate the price of the bond at maturity, assuming a yield of 8%:

PV = 60 / (1+0.08)^1 + 60 / (1+0.08)^2 + 60 / (1+0.08)^3 + 60 / (1+0.08)^4 + 1060 / (1+0.08)^5
PV = 935.82

So the bond will be worth $935.82 at maturity.

The total coupon payments over the life of the bond will be:

60 + 60 + 60 + 60 + 60 = 300

Therefore, the total return on the bond will be:

(935.82 + 300 - 1033.02) / 1033.02 = 0.0711, or 7.11%

So the realized horizon yield is 7.11%, which is closest to answer choice B.

Assume That You Purchase a Five-Year, $1,000 Par Value Bond