Suppose that you buy a 5 year bond, with a face value of $2 000, a coupon rate of 2%, and a price of $1 908.41.

a. Calculate the yield to maturity of this bond. AFTER you buy the bond, market interest rates rise to 4%.

b. What will your rate of return be if your holding period is the full 5 years?

c. If you unexpectedly need to sell the bond at the end of the second year, what will your rate of return be?

d. Explain the concept of “interest rate risk” and why it means you probably shouldn’t buy bonds during the recovery phase of the business cycle.