An investor purchases a $10,000, 5-yr corporate note one year ago for $10,440. The note pays an annual coupon of $600. Over the past year, the note’s annual yield to maturity has dropped by 1%. What total return did the investor earn over the year?
Answer is : 8.5%
Can someone talk me through the work – I understand you start by using TVM to get I/Y which is 4.9842%. The next step says value note at yield of 3.9842% w/ 4 yrs to maturity. How did they get that?
First, find today’s price - I don’t have my calculator with me, but it’ll be the PV of the remaining cash flows on the note at TODAY’s yield (which is 1% less than the yield at time of purchase)
The price of pretty much anything (per CFA curriculum) is the PV of the remaining cash flows at the appropriate rate.
Once you have today’s price, the return is (ending price + Coupon - beginning price)/Beginning price
“Over the past year . . .”
So, it’s one year later. After one a 5-year note will have 4 years left until maturity.
“. . . the note’s annual yield to maturity has dropped by 1%.”
4.9842% – 1% = 3.9842%.
Calculate the YTM by putting the values given, you will get 4.9842%.
And suddenly yeild droped by 1% which is 3.9842%.