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Suppose that the current spot rate curve (annually compounded) is s1=0.2%, s2=0.8%, s3=1.2%.

Assume that one year from now, the spot rate curve will be s'1=0.8%, s'2=1.4%, s'3=1.8%.

Consider a 3-year bond with annual coupon 5%. If you purchase that bond today and hold it for one year, what will be your total return (i.e. consider both price change and coupon)? (nearest 0.01%, and e.g. write 5.02 for 5.02%).

Answer should be: 0.77

What I have tried: step 1: find the current price of a three year bond: 111.2199

Find the sell price: 105/1.008= 104.16

But why the sell price is less than a buy price? and I m ending up with negative return. How to get to 0.77?

Thank you!!!

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  • $\begingroup$ "But why the sell price is less than a buy price? " because the interest rates went up. $\endgroup$ – D Stanley Jan 12 at 17:33
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Hopefully clear from the table below. On the left, the NPV of the bond today is 111.2199, exactly as you say. On the right is the same for 12 months time, after the payment of the first coupon.

enter image description here

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