I struggle with a simple example. It seems like I am missing a point …
Assume a flat yield curve of 6%. A three-year 100 bond is issued at par paying an annual coupon of 6%. What is the bond’s expected return if a trader predicts that the yield curve one year from today will be a flat 7%?
My solution: In t0 the bond trades at par = 100, in t1 the bond should trade at 6/1,07 + 106/1,07^2 = 98,192. Return = 98,192/100 - 1 = -1,81%
I am not 100% on this but you are showing the value @ t1 and calculating your return on that, you are ignoring the fact that the bond is earning interest up until that point.
Thinking this right, the official answer is wrong and I rather accept yours as correct ThomasW
The intuitive way to answer this would say that if interest rates are going to rise, then the bond price should fall, so if we hold the bond until end-year 1, then we will make a loss.
Second, we always valorize bonds with future cash flows, so that “6$” coupon paid today must not be counted for the price. Thus correct valuation is P1 = 6/1.07 + 6/1.06^2
First we value the bond after a year (Changed YTM) then we add the cuponn already received 6
Should be around 104.19.
Then we justt use HPR formula p1/p0 -1
You might have got that right, man, good job! I think, this reading is probably the worst explained in CFAII jajaja. I don’t doubt the competences of the authors, but they struggle in making points clear over easy stuff. For example in the exercise you guys are discussing, they do not clearly state that they want to know the return after one year: They just say that the yield changes after one year.