Question

The Potomac Company’s bonds have a face value of $1,000, will mature in 20 years, and carry a coupon rate of 16 percent. Assume interest payments are made semiannually. Determine the present value of the bond’s cash flows if the required rate of return is 15 percent.

Find the real return on the following investments:

Stock    Nominal      Return Inflation

A          10%             3%

B          15%            8%

C           -5%            2%

Answer 1

the present value of the bond will be :

we can calculate the PV by the BA ii plus calculator,

where the strokes will be as:

FV = $1000

N= 40 YEARS ( COMPOUNDED SEMI ANNUALLY )

PMT = 0.16/2 * 1000 = $80

I/Y = 15%/2 = 7.5 %

THE PV =( $1062.9)

WE CAN ALSO CALCULATE THIS MANUALLY:

80/1.075 + 80/1.0755^2 + ..........1080/ 1.075 ^ 40

= ($1062.9)

The real rate of return is the effective rate after adjusting for inflation = (1 + nominal)/ ( 1+ inflation)

for stock A real return is

=1.10/1.03 - 1

=6.796%

for stock B the real return is :

1.15/1.08 - 1

= 6.48%

for stock C the real return is :

0.95/1.02 - 1

-6.86%