Question

a) The ARA Corporation bonds have a coupon of 14%, pay interest semi-annually, and they will mature in 7 years. Your required rate of return for such an investment is 10% annually.

i) How much should you pay for a $1,000 ARA Corporation bond?

ii) If you are given RM90, 000, how many units of bond can you purchase?

iii) What is the yearly interest income for this bond if I purchase it with RM90, 000?

iv)You plan to reinvest the coupon interest at 12% rate of return per annum. Calculate the value of the reinvestment, what is the figure will you get at the end of 7th years with your principle.

Answer 1

i]	Price that can be paid = 1000/1.05^14+70*(1.05^14-1)/(0.05*1.05^14) =	$ 1,197.97
ii]	Number of units that can be purchased = 90000/1197.97 =	75.13	Units
ii]	Yearly interest income = 75.13*1000*14% =	$ 10,518.20
iv]	Value of the reinvestment = (10518.20/2)*(1.06^14-1)/0.06 =	$ 110,520.33
	The amount of $110,520.33 is in addition to the maturity
	value of $90,000. So the total amount at the end of the 7th
	year = 110,520.33+90,000 = $200,520.33.