Question

You buy an eight year bond that has a 6% current yield and a 6% coupon (paid annually). In one year, promised yields to maturity have risen to 7%. What is your holding period return?

Answer 1

Assumption: Holding period - one year; return on the security is considered as cash inflow +/- apprecication/depreciation of market value of the security

At the date of purchase the bond was traded at par (coupon rate = current yield), therefore the value is 100%. In a year the buyer of the bond receives 6% coupon; at the same time the market value of the bond depreciates on 14% (6%/7% see: Current yield formula). Suppose the holder of the bond sells it on the market. Holding period return on the bond equals 6%-14%=-8%

Answer 2

.61%

Answer 3

.61% is correct. The ultimate equation used to calculate the holding period return is (ending price-beginning price+coupon)/ beginning price.

So with the original scenario:
FV=1000
N=8
PMT=60
I/Y=6
PV=???=-1000

Since the YTM changes to 7, we need to change our I/Y. And since it is a year later, our N has one less period(one less year). So now, the PV is calculated like this:
FV=1000
PMT=60
N=8-1=7
I/Y=7
PV=???= 946.11

So with 946.11 as our ending price, our holding period return is:

(946.11-1000+60)/1000=.0061=.61%