Interest rate risk has two (2) components: price (value) risk and reinvestment risk.

Consider a bond that matures exactly 5 years from now, pays a 4% annual coupon and has a $100 par (face) value.

a.) Suppose the current market price of the bond is $91.58, what is the annual rate of return (yield to maturity) implied by this price?

b.) Suppose that an investor with a 2-year investment horizon purchases the bond above (for $91.58) and will sell it exactly two (2) years from today. Immediately after this investor purchases the bond, all interest rates (yields) in the economy rise to 10%. Compute the 2-year (horizon) return for this investor.

c.) Comparing your answers in parts a.) and b.) above, how did the increase in yields (to 10%)affect this investor with the 2-year investment horizon.

d.) Is your answer in part c.) above the result of price (value) risk or reinvestment risk?