1. Suppose Floyd Motor Company sold an issue of bonds on January 1, 2001. The bonds were sold for $1,000 per unit (i.e., they were issued at par), had a 10 percent coupon rate payable semi-annually, and matures in 15 years, i.e., on December 31, 2015.
a) If you bought the bond on the issue date at the issue price and expected to hold it until it matures on December 31, 2015, what would be your average annual rate of return on the investment?
b) Two years after the bonds were issued the going rate of interest on similar bonds fell to 8 percent. At what price would the bonds sell?
c) Six years after the initial offering, the going interest rate on similar bonds rose to 12 percent. At what price would the bonds sell?
d) Eight years after the issue, the bonds were selling for $925. What is the bond's yield to maturity at this point? What is the current yield? What is the capital gains yield?
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The solution computes fair value of bond issued under different circumstances and scenarios in the attached Excel file.