You purchase a 10year 1000 bond with a coupon rate of 12 per

You purchase a 10-year, $1,000 bond with a coupon rate of 12 percent paid annually. The market rate almost immediately falls to 10 percent.

a. What would be your rate of return if you had purchased the bonds with a margin requirement of 30 percent?

b. What would be your rate of return if the interest rates increased, immediately after purchase, to 14 percent?

Solution

a) Price of the bond when the market rate of return falls to 10% = 1000/1.10^10+120*(1.10^10-1)/(0.10*1.10^10) = $ 1,122.89 Return = (1122.89-1000)/(1000*30%) = 40.96% b) Price of the bond when the market rate of return rises to 10% = 1000/1.14^10+120*(1.14^10-1)/(0.14*1.14^10) = $     895.68 Return = (895.68-1000)/(1000*30%) = -34.77%