Question

1. Cy owns investment A and 1 bond B. The total value of his holdings is 1,517 dollars. Bond B has a coupon rate of 8.4 percent, par value of $1000, YTM of 8.42 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 70.82 dollars in 1 year, and subsequent annual cash flows are expected to increase by 1.77 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

Value of investment A:

= $1,517 - $998.21

= $518.79

Expected return on investment A:

= $70.82/$518.79 + 1.77%

= 0.1542

Hence, Expected return on investment A is 0.1542