5 Interest Rates and ReturnsFor investors, the distinction between interest rates and returns on bonds can be quiteimportant.The rate of return on a bond takes into account not only any interest payments made bythe bond, but also any changes in the price of the bond itself.Example: Consider a coupon bond with $1,000 face value and $100 coupon payment (10%coupon rate) that is bought today for $1,000.If interest rates fall over the next year, the bond price will rise.Suppose, to continue the example, that the investor is able to sell the bond one year fromnow at the price of $1,200.Then the investors total earnings from holding the bond include the $100 coupon paymentplus the capital gain of $1,200-$1,000 = $200.Expressing these earnings as a percentage of the original purchase price gives us a totalreturn on the investment of
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