Suppose that the term structure is currently flat so that bonds of all maturities have yields to maturity of 10%. Currently a 5 year coupon bond with annual coupons (with the first one due in 1 year) and face value of $1,000 is selling at par.

Suppose that the term structure is currently flat so that bonds of

all maturities have yields to maturity of 10%. Currently a 5 year coupon bond with annual coupons (with the first one due in 1 year) and face value of $1,000 is selling at par.

A year from now interest rates will be depend on the stance of monetary policy. If monetary policy is “tight” the yields to maturity on all bonds will be 12%. If monetary policy is “loose” the yields to maturity on all bonds will be 8%.

If you sell the bond a year from now when monetary policy is tight what will be the return to your investment over the year? If you sell the bond a year from now when monetary policy is loose what will be the return to your investment over the year?

 
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