Question

Suppose Scarlett purchased a 3-year bond with the face
value of 20,000 in the primary market. The current risk-free interest rate was
0.25%, and a risk premium on that bond is 3%. A year later after collecting her
yearly coupon payment, Scarlett decided to sell that bond in the secondary market.
By that time, the economic situation has improved, and the risk-free interest rate
has risen to 1%. What is Scarlett’s rate of return for the one-year period she held
the bond?

Answer 1

Rate of return of the bond = $\frac {End value of principal + coupon interest- Beginning value of principal}{ Beginning value of principal} \times 100$

Expected return after one year = 3+0.25= 3.25%

Coupon interest= $\frac {3.25}{100} \times 20000 = 650$

End value of principal = $1.0325 \times 20000= 20650$

Substitute the values into the above formula

Therefore $\frac {20650 + 650- 20000} {20000} \times 100$

Rate of return for the year = 6.5 %