Question Help 6-22 (similar to) Suppose you purchase a 10-year bond with 6 6% an

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Question Help 6-22 (similar to) Suppose you purchase a 10-year bond with 6 6% annual coupons. You hold the bond for four years, and sell it immediately after receivin the fourth coupon. If the bond's yield to maturity was 46% when you purchased and sold the bond. a. What cash flows will you pay and receive from your investment in the bond per $100 face value? b. What is the annual rate of return of your investment? a. What cash flows will you pay and receive from your investment in the bond per $100 face value? The cash flows from the investment are shown in the following timeline: (Round to the best choice below.) O A. Year Cash Flows $115.75 $6.60 $6.60 $6.60 S116.88 OB. Year Cash Flows$116.88 $6.60 $6.60 $6.60 $110 28 O C. Year Cash Flows $115.75 $6.60 $6.60 $6.60 $116.88 OD. Year Cash Flows $110.28 $6.60 $6.60 $116.88 Click to select your answer and then click Check Answer part remaining Clear All Check Answer

Explanation / Answer

Correct Answer:A

Part 1 - Calculation of Cash Flow at inception i.e. Year 0

Purchase Price of the Bond will be the present value of all cash inflows incurring during the period of the bonds.

Part -2 :Calculation of Cash Flows at end of Year 4.

This cash flow will be sum of receipts from sale of bond and annual coupon of $6.60

Calculation of Sale Price at Year 4. It will be present value of interest coupon available in reminaing period of bond and its redemption vaue at year 10.

Total Cash inflow is $ 110.28 + 6.60 = 116.88

Calculation of Rate of Return on our investment:

At the time of purchase of bond yield to maturity was 4.60% and at the time of sale it was still 4.60%. So rate of return on our investment is 4.60%. The same can be confirmed as follows:

It can be seen that PV of cash inflows discounted at 4.60% is equal to purchase price of the bond.

Year Cash Inflows PVIF @ 4.6% PV of Cash Inflows 1 6.6             0.9560                  6.31 2 6.6             0.9140                  6.03 3 6.6             0.8738                  5.77 4 6.6             0.8354                  5.51 5 6.6             0.7986                  5.27 6 6.6             0.7635                  5.04 7 6.6             0.7299                  4.82 8 6.6             0.6978                  4.61 9 6.6             0.6671                  4.40 10 106.6             0.6378                67.99 Total 115.75

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