A three-year 9% bond is trading at par of $5,000. If you buy the bond expecting to hold it to maturity and believe you can reinvest the $225 semi-annual coupon payments at a 3.5% semi-annual rate through maturity. The total return on this investment is _____ annually.
A) 3.50%
B) 4.50%
C) 7.00%
D) 8.80%
E) 9.00%

Question

Quizplus · Accepted Answer

Since the bond is trading at par, the yield to maturity is equal to the coupon rate, which is 9%. 
Using the semi-annual interest rate of 3.5% to reinvest the $225 coupon payments, the total future value of the bond at maturity would be:

$5,000 + ($225 × 1.035) + ($225 × 1.035)^2 + ($225 × 1.035)^3 = $5,876.96

Therefore, the total return on this investment would be:

($5,876.96 / $5,000)^(1/3) - 1 = 8.80% annually

So, the best choice is D.

A Three-Year 9% Bond Is Trading at Par of $5,000