A:
A 6.4% coupon bond that is expected to mature in five years is currently trading at 96.825. If the annualized reinvestment rate is expected to be 5.8%, what will this bond's effective annual total return be?
A) 6.63%
B) 7.17%
C) 7.11%
D) 6.39%
A) 6.63%
B) 7.17%
C) 7.11%
D) 6.39%
The correct answer is: C)
Step 1: Future value of reinvested coupons.
PMT = 3.20; n = 10; I = 2.9%
Therefore, FV = 36.516
Step 2: Total FV at maturity = (FV of coupons + Par)
= 36.516 + 100
= 136.516
Step 3: Calculate Holding Period Return
= 136.156/96.825  1 = 40.99%
Step 4: Calculate the effective annual total return
(1.4099)^{1/5}  1 = 7.11%
or,
(1.4099)^{1/10}  1 = 3.495% (this is the effective 6month yield)
Therefore, (1.03495)^{2}  1 = 7.11%
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