Question

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.

Answer 1

a)

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.