On September 1, 2012, Al buys a bond for $15,000 that makes coupon payments of $750 after each of the following three years and returns its principal of $15,000 at the end of the three years. In other words, it is a standard coupon bond with a 5 percent annual interest rate making payments once each year.On September 1, 2013, Al receives his first coupon payment of $750. At that time, the market interest rate on bonds like Al's has risen to 6 percent. Al sells his bond to Biff at that time, for a price equal to the present value of the bond's payments.
a.How much does Biff pay Al for the bond?
b.Calculate Al's current yield, capital-gains yield, and total return for the year.On September 1, 2014, Biff receives a coupon payment of $750. The market interest rate on bonds like his remains 6 percent. Biff sells his bond to Cass at that time, for a price equal to the present value of the bond's payments.
c.How much does Cass pay Biff for the bond?
d.Calculate Biff's current yield, capital-gains yield, and total return for the year.On September 1, 2015, Cass receives a coupon payment of $750 and the principal of $15,000. Over the course of the year (between September 1, 2014, and September 1, 2015), the market interest rate on bonds like his rose to 7 percent. But Cass decided to keep the bond.
e.What is Cass's total return for the year?Explain and show all your work for each part.
| a. |  |
| b. |  |
 | |
| Total return = current yield + capital-gains yield = 5% ? 1.83% = 3.17% | |
| c. |  |
| d. |  |
 | |
| Total return = current yield + capital-gains yield = 5.09% + 0.91% = 6% | |
| You should expect this because Biff bought the bond at a yield to maturity of 6 percent and held it for a year, and the market interest rate did not change. | |
| e. | Six percent, since Cass bought it when the yield to maturity was 6 percent and held it until it matured. |
| You could also do this one the hard way: | |
 | |
 | |
| Total return = current yield + capital-gains yield = 5.05% + 0.95% = 6% |
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