You buy a 7-year coupon bond for $995. The bond has a face value of $1,000 and an annual coupon rate of 5%.

(1) If you sell the bond one year later for $1,275, what is your percentage rate of return? (5 marks)

(2) What kind of risk do you face if you sell this bond before maturity? (2 marks)
(3) Would you have the same type of risk if you held this bond until maturity, i.e., for the full seven years? Explain. (2 marks)

(4) If you expect the inflation rate to be 4 percent next year and a one-year

bond has a yield to maturity of 2 percent, what is the real interest rate on this bond? If you were a pensioner, would you buy this bond? Why or why not? (6 marks)

Answer rating: 100% (QA)

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