with the stock market reflecting extreme volatility during the past few weeks, some individuals are becoming concerned about their equity portfolio’s and are either considering selling their stocks or have already done so. Many investors are looking for stability and believe the bond market is a safe haven for their money.
Using the following information, please compute the investment performance and end of period asset value for the following “realistic” scenario.
A $100,000 investment in a 15 year, AA-rated corporate bond with a 5 percent coupon. Please calculate the annual interest income that you would receive each year, along with the value that you will receive when your bond matures.
The 15-year average return for the S&P 500 from January 1973 to December 2016 (29 separate 15 year periods) was as high as a 20% average annual return and as low as a 3.7% average annual return. Additionally, the average dividend yield for the S&P is 4.11% and the average annual dividend growth rate is 6.11%.
Using this information, please compare the investment in the 5% 15 year corporate bond with a $100,000 investment in a stock with a 3.7% dividend yield (10 percent less than the S&P 500 average yield) and a 3% dividend growth rate (50 percent of the S&P 500 dividend growth rate).
The annual investment returns are as follows:
Year 1 (13.40%) Year 2 (23.37%) Year 3 26.38% Year 4 8.99%
Year 5 3.00% Year 6 13.62% Year 7 3.53% Year 8 (38.49%)
Year 9 23.45% Year 10 12.78% Year 11 0.00 Year 12 13.41%
Year 13 29.60% Year 14 11.39% Year 15 (0.73%)
The bond interest payment of 5 percent is paid annually and not reinvested. To compare accurately with the bond investment, the stock dividend will not be reinvested, but paid annually as well.
Please calculate the value of the stock account at the end of each year and the dividend income from the stock on an annual basis.
Once you have performed the calculations, please let me know if you prefer to invest in a 5% corporate bond for 15 years or the stock and why.
What is the value of the stock after year 2? Year 8? Year 11? When does the annual dividend income of the stock exceed the annual interest income of the bond?
1. The IRR of investment in Bond is 5% as given below
| Year | Value of Investment | Explanation |
| 0 | (100,000) | Initial Value of Investment |
| 1 | 5,000 | Annual Coupon = 5% X 100000 = 5000 |
| 2 | 5,000 | Same as above |
| 3 | 5,000 | Same as above |
| 4 | 5,000 | Same as above |
| 5 | 5,000 | Same as above |
| 6 | 5,000 | Same as above |
| 7 | 5,000 | Same as above |
| 8 | 5,000 | Same as above |
| 9 | 5,000 | Same as above |
| 10 | 5,000 | Same as above |
| 11 | 5,000 | Same as above |
| 12 | 5,000 | Same as above |
| 13 | 5,000 | Same as above |
| 14 | 5,000 | Same as above |
| 15 | 105,000 | Annual coupon (5000) + Par Value (100000) |
| IRR | 5.00% |
2. The returns from stock investment are price appreciation + dividend earned as explained below :
| Year | Value of Investment | Growth Rate | Average Dividend Yield | Dividend | Cash Flows | Explanation |
| 0 | 100,000 | (100,000.00) | Initial Value of Investment | |||
| 1 | 86,600 | -13.40% | 3.70% | 3,204.20 | 3,204.20 | Dividend Earned = Dividend Yield X Value of Investment |
| 2 | 66,362 | -23.37% | 3.70% | 2,455.38 | 2,455.38 | Same as above |
| 3 | 83,868 | 26.38% | 3.70% | 3,103.11 | 3,103.11 | Same as above |
| 4 | 91,407 | 8.99% | 3.70% | 3,382.08 | 3,382.08 | Value of Investment = Previous year Investment Value x (1+ Growth Rate) |
| 5 | 94,150 | 3.00% | 3.70% | 3,483.54 | 3,483.54 | Same as above |
| 6 | 106,973 | 13.62% | 3.70% | 3,958.00 | 3,958.00 | Same as above |
| 7 | 110,749 | 3.53% | 3.70% | 4,097.71 | 4,097.71 | Same as above |
| 8 | 68,122 | -38.49% | 3.70% | 2,520.50 | 2,520.50 | Same as above |
| 9 | 84,096 | 23.45% | 3.70% | 3,111.56 | 3,111.56 | Same as above |
| 10 | 94,844 | 12.78% | 3.70% | 3,509.22 | 3,509.22 | Same as above |
| 11 | 94,844 | 0.00% | 3.70% | 3,509.22 | 3,509.22 | Same as above |
| 12 | 107,562 | 13.41% | 3.70% | 3,979.81 | 3,979.81 | Same as above |
| 13 | 139,401 | 29.60% | 3.70% | 5,157.83 | 5,157.83 | Same as above |
| 14 | 155,279 | 11.39% | 3.70% | 5,745.31 | 5,745.31 | Same as above |
| 15 | 154,145 | -0.73% | 3.70% | 5,703.36 | 159,848.36 | Final value of Investment + Dividend Earned |
| IRR | 5.96% |
The IRR of Investment in stock is 5.96%
Investment in stock has a better return than bond, so stock is preferred.
Every year Investment is calculated on growth rate and previous year price,
thus year 1 investment value = 100000 X (1+ (-13.40%) = 86,600, Similarly for others are calculated in the table
The Dividend in year 1 = Dividend Yield X Price = 3.7% x 86,600 = 3204.20. Similarly for others can be calculated
Value of stock after year 2 = $66,362
Value of stock after 8 = $68,122
Value of stock after year 11 = $94,844
Annual dividend exceeds the value of coupon in year 13, 14, 15 (from tables of cash stock and bond above)
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