125
C
HAPTER
4
4
UN
DER
ST
A
N
DI
NG
F
IXED-I
NCO
ME RI
SK
AN
D RET
U
R
N
SOLUTIONS
1 . A is correct. A capita
l
gain is
l
east
l
i
k
e
l
y to contri
b
ute to t
h
e investor’s tota
l
return.
ere
is no capita
l
gain (or
l
oss)
b
ecause t
h
e
b
on
d
is
h
e
ld
to maturity.
e carrying va
l
ue o
f
t
h
e
b
on
d
at maturity is par va
l
ue, t
h
e same as t
h
e re
d
emption amount. W
h
en a
xe
d
-rate
b
on
d
is
h
e
ld
to its maturity, t
h
e investor receives t
h
e principa
l
payment at maturity.
is
principa
l
payment is a source o
f
return
f
or t
h
e investor. A
xe
d
-rate
b
on
d
pays perio
d
ic
coupon payments, an
d
t
h
e reinvestment o
f
t
h
ese coupon payments is a source o
f
return
f
or t
h
e investor.
e investor’s tota
l
return is t
h
e re
d
emption o
f
principa
l
at maturity an
d
t
h
e sum o
f
t
h
e reinveste
d
coupons.
2 . C is correct. Because t
h
e
xe
d
-rate
b
on
d
is
h
e
ld
to maturity (a “
b
uy-an
d
–
h
o
ld
” investor),
interest rate ris
k
arises entire
l
y
f
rom c
h
an
g
es in coupon reinvestment rates. Hi
gh
er interest
rates increase income
f
rom reinvestment o
f
coupon payments, an
d
l
ower rates
d
ecrease
income
f
rom coupon reinvestment.
ere wi
ll
not
b
e a capita
l
g
ain or
l
oss
b
ecause t
h
e
b
on
d
is
h
e
ld
unti
l
maturity.
e carryin
g
va
l
ue at t
h
e maturity
d
ate is par va
l
ue, t
h
e same
as t
h
e re
d
emption amount.
e re
d
emption o
f
principa
l
d
oes not expose t
h
e investor to
interest rate ris
k
.
e ris
k
to a
b
on
d
’s principa
l
is cre
d
it ris
k
.
3 . A is correct. Capita
l
g
ains (
l
osses) arise i
f
a
b
on
d
is so
ld
at a price a
b
ove (
b
e
l
ow) its
constant-yie
ld
price tra
j
ectory. A point on t
h
e tra
j
ectory represents t
h
e carryin
g
va
l
ue o
f
t
h
e
b
on
d
at t
h
at time.
at is, t
h
e capita
l
g
ain/
l
oss is measure
d
f
rom t
h
e
b
on
d
’s carryin
g
va
l
ue, t
h
e point on t
h
e constant-yie
ld
price tra
j
ectory, an
d
not
f
rom t
h
e ori
g
ina
l
purc
h
ase
price.
e carryin
g
va
l
ue is t
h
e ori
g
ina
l
purc
h
ase price p
l
us t
h
e amortize
d
amount o
f
t
h
e
d
iscount i
f
t
h
e
b
on
d
is purc
h
ase
d
at a price
b
e
l
ow par va
l
ue. I
f
t
h
e
b
on
d
is purc
h
ase
d
at
a price a
b
ove par va
l
ue, t
h
e carryin
g
va
l
ue is t
h
e ori
g
ina
l
purc
h
ase price minus (not p
l
us)
t
h
e amortize
d
amount o
f
t
h
e premium.
e amortize
d
amount
f
or eac
h
year is t
h
e c
h
an
g
e
in t
h
e price
b
etween two points on t
h
e tra
j
ectory.
