As part of a capital raising exercise, Immaturity, Inc. sold 20-year, 6% semi-annual coupon bonds with a face value of $1,000 at a discounted price of $950 each.
(a) Calculate the yield to maturity on these bonds. (3 marks)
(b) Suppose an investor that buys these bonds reinvests the coupon payments received. How much in total would the investor have at maturity if he reinvested his received coupons at:
(i) 4.30%, compounded semiannually? (3 marks)
(ii) 6.45%, compounded semiannually? (3 marks)
(c) What is the actual average return when coupons are reinvested as in parts 3(b)(i) and 3(b)(ii), expressed as an annual quoted rate with semiannual compounding? The yield to maturity is often interpreted as the average annual expected return if an investor holds the bond until it matures. What is the implicit assumption in this interpretation? (5 marks)
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