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Chapter 4: Q.10 (page 134)

True or False: With a discount bond, the return on the bond is equal to the rate of capital gain.

Short Answer

Expert verified

True, with a discount bond, the return on bond is equal to the rate of capital gain.

Step by step solution

01

Step 1. Introduction 

A bond is a debt instrument issued by governments or businesses to raise funds. Bondholder is a person who holds bonds. By purchasing a bond, the investor lends money to the bond issuer and in return gets the principal amount back along with interest upon maturity of the bond.

02

Step 2. Explanation

The current yield plus the rate of capital gain. A discount bond has no coupon payments by definition, hence the current yield for a discount bond is always zero (zero coupon payment divided by current price).

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Most popular questions from this chapter

A \(1,100-face-value bond has a 5% coupon rate, its current price is \)1,040, and it is expected to increase to $1070 next year. Calculate the current yield, the expected rate of capital gains, and the expected rate of return

If the interest rate is 15%, what is the present value of a security that pays you \(1,100 next year, \)1,250 the year after, and $1,347 the year after that?

The U.S. Treasury issues some bonds as Treasury Inflation Indexed Securities, or TIIS, which are bonds adjusted for inflation; hence the yields can be roughly interpreted as real interest rates. Go to the St. Louis Federal Reserve FRED database, and find data on the following TIIS bonds and their nominal counterparts. Then answer the questions below.

  • 5-year U.S. Treasury (DGS5) and 5-year TIIS (DFII5)
  • 7-year U.S. Treasury (DGS7) and 7-year TIIS (DFII7)
  • 10-year U.S. Treasury (DGS10) and 10-year TIIS (DFII10)
  • 20-year U.S. Treasury (DGS20) and 20-year TIIS (DFII20)
  • 30-year U.S. Treasury (DGS30) and 30-year TIIS (DFII30)

a. Following the Great Recession of 2008鈥� 2009, the 5-, 7-, 10-, and even the 20-year TIIS yields became negative for a period of time. How is this possible?

b. Using the most recent data available, calculate the difference between the yields for each of the pairs of bonds (DGS5 鈥� DFII5, etc.) listed above. What does this difference represent?

c. Based on your answer to part (b), are there significant variations among the differences in the bond-pair yields? Interpret the magnitude of the variation in differences among the pairs.

Calculate the present value of a $1,300 discount bond with seven years to maturity if the yield to maturity is 8%.

Suppose today you buy a coupon bond that you plan to sell one year later. Which part of the rate of return formula incorporates future changes into the bond鈥檚 price?
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