A zero-coupon bond has a $1,000 face value, matures in 10 years, and currently sells for $781.20.
a. What is the market's required return on this bond?
b. Suppose you hold this bond for 1 year and sell it. At the time you sell the bond, market rates have increased to 3.5%. What return did you earn on this bond?
c. Suppose that rather than buying the 10-year zero-coupon bond described at the start of this problem, you instead purchased a 10-year 2.5% coupon bond (assume annual payments). Because the bond's coupon rate equaled the market's required return at the time of purchase, you paid par value ($1,000) to acquire the bond. Again assume that you held the bond for one year, received one coupon payment, and then sold the bond, but at the time of sale the market's required return was 3.5%. What was your return for the year? Compare your answer here to your answer in part (b).