You buy a very risky bond thatpromises a 9.5% coupon and return of the $1,000 pr
ID: 2662329 • Letter: Y
Question
You buy a very risky bond thatpromises a 9.5% coupon and return of the
$1,000 principal in 10 years. You payonly $500 for the bond.
a. You receive the coupon payments forthree years and the bond defaults. Afterliquidating
the firm, the bondholders receive adistribution of $150 per bond at the end of 3.5
years. What is the realized return onyour investment?
b. The firm does far better thanexpected and bondholders receive all of thepromised
interest and principal payments. What is therealized return on your investment?
Explanation / Answer
3
-95
500.00
-1,000
0.3734
37.34%
$500.00
$1,000
9.50%
10 years
10
-95
500.00
-1,000
0.2242
22.42%
(a) Calculating Realized Return onInvestment (Rate): Present Value of theBond $500.00 Par Value of theBond $1,000 Annual Coupon Rate 9.50% Number of Years toMaturity 3.5 years Calculating RealizedReturn on Investment (Rate): (Using Ms-Excel "RATE"Function): Number of years toMaturity3
Annual Coupon Payment (PMT) ($1000 *8.50%)-95
Present Value of the Bond(PV)500.00
Future Value (or) Parvalue of theBond (FV)-1,000
Realized Rate of Return onInvestment (Rate)0.3734
Realized Return onInvestment (Rate)37.34%
(b)Calculating Realized Return onInvestment (Rate): Present Value of theBond$500.00
Par Value of theBond$1,000
Annual Coupon Rate9.50%
Number of Years toMaturity10 years
Calculating Realized Returnon Investment (Rate): (Using Ms-Excel "RATE"Function): Number of years toMaturity10
Annual Coupon Payment (PMT) ($1000 *8.50%)-95
Present Value of the Bond(PV)500.00
Future Value (or) Parvalue of theBond (FV)-1,000
Realized Rate of Return onInvestment (Rate)0.2242
Realized Return onInvestment (Rate)22.42%
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