Suppose that the market interest rate increases to 6.875 percent annually compounded (increase by 87.5 basis points) during the first year of your purchase (within year 1), and it remains at that level (6.875 percent) for the next five years. Assume that, the reinvestment rate for the first coupon payment is the new interest rate, that is, 6.875 percent annually compounded. In addition, you will reinvest the coupon payments in a zero-coupon bond. [You already computed total proceeds (both from reinvestment of coupon payments plus face value) at the end of your investment horizon (t=6) years in Part B of the problem.] Now, what is your annually compounded holding period return (HPR) at the end of your investment horizon (t=6) years?

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topeadeniran2 topeadeniran2 · Answer 1 · 2021-10-15T22:24:35+02:00

The annually compounded holding period return (HPR) at the end of the investment horizon (t=6) years is 6.98%

Therefore, the price of the bond at year 0 will be:

= 70 × (1-(1+6%)⁻⁶)/6% )+ 1000/(1+6%)⁶

= 1049.17

Then, the reinvestment rate will be =6.875%

Number of years of coupons =6

The future value of reinvestment of the coupon and the receipt of par value at year 6 will be:

= 70 × ((1+6.875%)⁵)/6.875% )+ 1000

= 1499.16

Therefore, the HPR at the end of Year 6 will be:

= (1499.16/1000)^(1/6 )- 1

= 6.98%

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