Question

16. Suppose that an investor with a five-year investment
horizon is considering purchasing a seven-year 7% coupon bond
selling at par. The investor expects that he can reinvest the
coupon payments at an annual interest rate of 9.4% and that at the
end of the investment horizon two- year bonds will be selling to
offer a yield to maturity of 11.2%. What is the total return on
this investment? Hint: Draw the cashflows of the 7 year bond. Using
Par Value of 100, investors pays 100 and receives 14 coupon
payments and Par Value of 100 at the end of 7 years. Part 1: As the
investor has hold the bond for 5 years, he will have received 10
coupon payments. With an reinvestment rate of 9.4% (s.a.
compounding), what is the coupons plus interest on coupons at the
end of 5 years? Part 2: At the end of year 5, what is the remaining
life of the bond? With a yield to maturity of 11.2%, what is the
value of the bond then? Total return of the investment is basically
the sum of values from Part 1 and Part 2.

16. Suppose that an investor with a five-year investment
horizon is considering purchasing a seven-year 7% coupon bond
selling at par. The investor expects that he can reinvest the
coupon payments at an annual interest rate of 9.4% and that at the
end of the investment horizon two- year bonds will be selling to
offer a yield to maturity of 11.2%. What is the total return on
this investment? Hint: Draw the cashflows of the 7 year bond. Using
Par Value of 100, investors pays 100 and receives 14 coupon
payments and Par Value of 100 at the end of 7 years. Part 1: As the
investor has hold the bond for 5 years, he will have received 10
coupon payments. With an reinvestment rate of 9.4% (s.a.
compounding), what is the coupons plus interest on coupons at the
end of 5 years? Part 2: At the end of year 5, what is the remaining
life of the bond? With a yield to maturity of 11.2%, what is the
value of the bond then? Total return of the investment is basically
the sum of values from Part 1 and Part 2.

Answer #1

On assuming, we have the face value of the bond is $1,000.

Bond is bought at par, initial investment = face value which is $1,000.

So, Coupon payment = $1,000 * 7% = **$70**

After five years of holding bond, he is getting 5 coupon payments

Reinvestment rate = **9.4%**

**The future value of these 5 coupon payments at the end
of investment horizon**

FV = (70/9.4%) * [ (1+9.4%)^5 -1 ] = $422

**The price of the two-year remaining bond at the yield to
maturity of 11.2%**

At the end of the investment horizon = [(70/1.112) + (1,070/1.112)^2] = $928

**Total receipt at the end of the investment horizon = The
future value of these 5 coupon payments at the end of investment
horizon + The price of the two-year remaining bond at the end of
the investment horizon**

= $422 + $928 = **$1,350**

**Total return** = Total receipt at the end of the
investment horizon / Initial investment

= [(1,350/1,000)-1]*100

= **13.5%**

Suppose that an investor with a five-year investment horizon is
considering purchasing a seven-year 9% (annual rate) coupon bond
selling at par. The investor expects that he can reinvest the
coupon payments at an annual interest rate of 9.4% and that at the
end of the investment horizon two-year bonds will be selling to
offer a yield to maturity of 11.2%. What is the total return for
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