Investor A has just sold a ten-year $10,000 corporate bond to Investor B for $8,500. Investor A purchased the bond four years ago for $9,500. The bond coupon rate is 8 percent per year paid annually and Investor A has just received the dividend for year 4.
a) Draw the cash flow diagram for Investor A
b) Calculate the Rate of Return for Investor A
c) Draw the cash flow diagram for Investor B
d) Investor B has a MARR of 10% per year compounded semi-annually. Will the return on the corporate bond meet the Investor B’s MARR?
Please do not use excel.
b) We find the rate of return using the financial calculator
Feed N = 4
PV = -9500
PMT = 800
FV = 8500
Compute i/Y = 6.02%
c) Total life of bond is 10 years, but 4 years have already passed. B will hold the bond for 6 years
We find the rate of return using the financial calculator
Feed N = 6
PV = -8500
PMT = 800
FV = 10000
Compute i/Y = 11.61%
d) MARR on annual compounding = (1+5%)^2 -1 = 10.25%
As expected return is 11.61%, bond will meet the investor B's MARR.
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