Question

The first meeting is with a high net-worth investor Ms. Saraswathy. She purchased a bond at a price of Rs. 104,800 that pays a coupon of 8% and a face value of Rs 100,000. This bond matures in 5-years from now. After investing in the bond yesterday She heard about another opportunity that pays a coupon of 5% PA in the first year, 7% PA in the second year, 9% PA in the third year, 10% PA in the fourth year and finally 12% PA in the fifth year. The price of this bond is Rs. 110,000 and a maturity of 5 years. She is anxious to know whether she made a mistake buying the 8% bond.

Did Saraswathy committed a mistake investing in 8% coupon bond? Show with necessary details.

Answer 1

Solution:

Here, the net present value of investment is ($ 6,005.31). Mr. Saraswathy invested money in bond equal to $ 1,04,800 but bond can only generate cash flow of $ 98,794.69 at this point of time after necessary adjustment for cost of capital which is $ 6,005.31 lower than cash outflow. Hence, Mr. Saraswathy took wrong decision for investing in this bond because it will results into loss of $ 6,005.31.