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"Bond P is a premium bond with a coupon rate of 8 percent", which makes annual payments, has YTM of 5 percent, and has ten years to maturity. If interest rates remain unchanged, what is the expected capital gains yield over the next year for Bond P?

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Answer:

The expected capital gain yield = -1.5%

Explanation:

Annual Bond Coupon Rate  Bond = 8%

Yield till maturity (YTM) = 5%

Lets take Bond Par Value = $1,000

For, Time to Maturity = 10 years,

Calculating Present Value of Bond,

Using Time value of money (TVM) Calculation,

Present Value (PV) = [Future value (FV) = 1000, Time (T) = 10, PMT = 80, I = 0.05]

PV = $1,231.65

Value of Bond = $1,231.65

For, Time to Maturity = 9 years,

Calculating Present Value of Bond,

Using TVM Calculation,

PV = [FV = 1000, T = 9, PMT = 80, I = 0.05]

PV = $1,213.23

Value of Bond = $1,213.23

Capital Gain Yield = (Ending Value - Initial Value)/Initial Value

Capital Gain Yield = (1213.23 - 1231.65)/1213.23

Capital Gain Yield = -1.5%

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