Question

HW9 #5)

Cy owns investment A and 1 bond B. The total value of his holdings is 1,899 dollars. Bond B has a coupon rate of 6.2 percent, par value of $1000, YTM of 6.38 percent, 17 years until maturity, and semi-annual coupons with the next coupon due in 6 months. Investment A is expected to produce annual cash flows forever. The next cash flow is expected to be 57.27 dollars in 1 year, and subsequent annual cash flows are expected to increase by 4.46 percent each year forever. What is the expected return for investment A? Answer as a rate in decimal format so that 12.34% would be entered as .1234 and 0.98% would be entered as .0098.

Answer 1

Current Value of Bond B is calculated in excel and screen shot provided below:

Current Value of Bond B is $981.49.

Total Value of Holding - $1,899.

So, Value of Investment A = $1,899 - $981.49

= $917.51.

Value of investment A is $917.51.

Expected return on investment A = ($57.27 / $917.51) + 4.46%

= 6.24% + 4.46%

= 10.68%

Expected return on investment A is 10.68%.