Basic Bond Math Interview Question
Hi all - I am expecting to receive an interview question on basic bond math that I was hoping someone here may have some insight into. The question will likely be as follows:
If you buy a bond at 80 (discount to par) with a 5% annual coupon, hold it for 5 years and sell it at par, what is your return?
Believe this will be a mental math question, so not expecting to be allowed to use a calculator. My simple brain assumes you take the 5% annual coupon and add the average annual return upon sale (20/100 = 20%/5 = 4%) to it to approximate a ~9% return, but I am almost sure that is oversimplifying it/just wrong in general. Any insight would be greatly appreciated!
Close. The growth of 80 to 100 should have 80 as the denominator, not 100.
That's a 25% return over 5 years = ~5%/year + the 5% coupon puts you at 10%. Actual math is 10.3%.
Semantics...this math is based on the bond "maturing" at par, not being "sold" at par.
Ah that makes sense. Thank you so much for the explanation - facepalm on using 100 instead of 80 as the denom.
It should be this: 5/80 = 6.25% from the coupon + (100-80)/5 = 4% from the yield = ~10.25% YTM
Total return (not annualized like YTM) is 100 (from principal) plus 25 from coupon (over five years) divided by 80 (what you paid for the bond) - 1 = 56.25%
Shouldn’t the actual be 11.25%? $5 per year coupon + $4 from discount ($20/5 years) so $9 of annualized yield (assuming $100 par). $9/$80 = 11.25%.
Yeah first comment is wrong, also for the 5% the denominator is 80, ie 6.25%
You arent getting the yield annually, thats the thing. You get it at EOP, which reduces IRR due to TVM
There we go, mixed up YTM / IRR with total annualized return
Harum inventore debitis fuga aliquid consequatur eum. Ut aut maxime fugit odit repudiandae et. Quaerat cupiditate nobis minima nulla a id voluptas.
Sapiente non rem dolorum et architecto hic molestiae. Sint illo porro voluptatem sed facere aliquid minus. Ut quo consequatur ratione maxime id eum iste et. Repudiandae incidunt nulla minus qui velit impedit iste. Qui modi quae aperiam dolores amet. Dolores voluptas quas enim quaerat voluptate et aut.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...