question archive Consider the following information about a coupon bond: Coupon rate: 2% Maturity: 5 years Face value: 100 Market interest rate: 4% You purchased this bond at a price of 100, but interest rates have since changed
Consider the following information about a coupon bond: Coupon rate: 2% Maturity: 5 years Face value: 100 Market interest rate: 4% You purchased this bond at a price of 100, but interest rates have since changed
Subject:FinancePrice:2.86 Bought3
Consider the following information about a coupon bond:
- Coupon rate: 2%
- Maturity: 5 years
- Face value: 100
- Market interest rate: 4%
You purchased this bond at a price of 100, but interest rates have since changed. Calculate the return on investment on this bond if you were to sell again right now before collecting the first coupon payment. If you had access to a new investment opportunity at 4.2% interest rate, should you hold the bond to maturity, or sell? Justify your answer.
Purchase A New Answer
Custom new solution created by our subject matter experts
GET A QUOTE
Answer Preview
If we had access to a new investment opportunity at 4.2% interest rate, we should sell the bond even before collecting the first coupon payment. As for the remaining years , we will have interest of 4.2% rather than 2 % and if we do the present value of 4.2% interest for the remaining 4 years at market interest rate , it will be
= Present value discounting factor of 4 % starting from year 2 * 4.2 = 14.60
while if we do the present value of 2% interest for the 5 years at market interest rate , it will be
= Present value discounting factor of 4 % starting from year 1 * 2 = 8.90
So it shows that it is better to sell 2% coupon rate bond asap and start investing at interest rate of 4.2 %
