Solution:
Annual coupon payment of the bond is $80
At the beginning of the year, remaining maturity period is 2 years.
Price of the bond is equal to face value, i.e. the initial price of the bond is $1000.
New price of the bond = present value of the final coupon payment + present value of the maturity amount.
New price of the bond = [tex]$\frac{80}{1+r} +\frac{1000}{1+r}$[/tex]
where, r is the yield to maturity at the end of the year.
Substitute 0.06 for r in the above equation,
Therefore new price of the bond is = [tex]$\frac{80}{1+0.06} +\frac{1000}{1+0.06}$[/tex]
= [tex]$\frac{1080}{1.06}$[/tex]
= $ 1010.87
Calculating the rate of return of the bond as
[tex]$\text{rate of return}=\frac{\text{coupon+new price-old price}}{\text{initial price}}$[/tex]
[tex]$=\frac{80+1018.87-1000}{1000}$[/tex]
= 0.09887
Therefore, the rate of return on the bond is 9.887%
≈ 10 %
