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You buy a UST with a remaining maturity of 10 years at 99, The coupon rate is 6%. You project that 1 year from today, the 9-year UST yield will be 5%. And you project that 2 years from today the 8-year UST yield will be 7% a.) What is your projected total rate of return for the 1-year and 2-year horizon holding periods? You assume that your interest income can be reinvested at an annual rate of 5%. Interest is paid semiannually, and par is $1,000

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beingteenowfmao

Answer:

Let's calculate the price of UST one-year from now using PV function

Insert N = 9 x 2 = 18, PMT = 6% x 1000 / 2 = 30, FV = 1000, I/Y = 5%/2 = 2.5%

=> Compute PV = $1,071.77 is the price in year 1

Similarly, price in year 2 can be calculated using I/Y = 7%/2 = 3.5% and N = 8 x 2 = 16

=> PV = $939.53 in year 2

Price today = $990

Now, total value at the end of year 1 = 30 x (1 + 5%/2) + 30 + 1071.77 = $1,132.52

Total Return for 1-year = 1,132.52 / 990 - 1 = 14.40%

Similarly, total value at the end of year 2 = 30 x (1 + 2.5%)^3 + 30 x (1 + 2.5%)^2 + 30 x (1 + 2.5%) + 30 + 939.53 = $1,034.10

Total Return for 2-year = 1,034.10 / 990 - 1 = 4.46%

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