Problem 3

A 20-year maturity bond with a 10% coupon rate (paid annually) currently sells at a yield to maturity of 9%. A portfolio manager with a 2-year horizon needs to forecast the total return on the bond over the coming 2 years. In 2 years, the bond will have an 18-year maturity. The analyst forecasts that 2 years from now, 18-year bonds will sell at yield to maturity of 8%, and that coupon payments can be reinvested in short-term securities over the coming 2 years at a rate of 7%.

1. a) What is the 2-year return on the bond

2. b) What will be the rate of return the manager forecasts that in 2 years the yield on 18-year bonds

   will be 10%, and that the reinvestment rate for coupons will be 8%?