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Assume that you bought a newly-issued Zero coupon bond and a newly-issued coupon bond with a 5.5% coupon on October 10, 2010 when both bonds had a yield-to-maturity of 5.5%. The par value of each bond is $1000. Both bonds mature on October 10, 2030. Unfortunately, the yield to maturity in the market for bonds with identical risk and maturity fell to 3% on October 1, 2016.
A) What was the price of each bond when you bought them on October 10, 2010?
B) On October 10, 2016, you decided to sell one of the bonds. Calculate the capital gain return in dollar terms of each bond. Use your answer in Part A as your purchase price and use the price on October 10, 2016 as the selling price. Thus the capital gain return is based on a 6 year period.
C) Which bond has a larger cumulative (6-year) percentage total return? Why?
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