Question

Cy owns investment A and 1 bond B. The total value of his holdings is 1,891 dollars. Bond B has a coupon rate of 8.88 percent, par value of $1000, YTM of 7.18 percent, 14 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 79.59 dollars in 1 year, and subsequent annual cash flows are expected to increase by 3.64 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

Market Value of bond is calculated in excel and screen shot provided below:

Market Value of bond is $1,148.58.

Total Value of holdings = $1,891.

Value of Investment 1 = $1,891 - $1,148.58

= $742.42.

Value of Investment 1 is $742.42.

Annual Cash flow from investment 1 = $79.59.

Rate of return on investment 1 = ($79.59 / $742.42) + 3.64%

= 10.72% + 3.64%

= 14.36%

Rate of return on investment 1 is 14.36%.