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Suppose you purchase a? ten-year bond with 5% annual coupons
Suppose you purchase a? ten-year bond with 5% annual coupons.You hold the bond for four years and sell it immediately after receiving the fourth coupon. If the? bond's yield to maturity was 4.01% 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 internal rate of return of your? investment?
Note?: Assume annual compounding.
Expert Solution
a). We can calculate the purchase price by using the following formula in excel:-
=-pv(rate,nper,pmt,fv)
Here,
PV = Purchase price
Rate = 4.01%
Nper = 10 periods
Pmt = Coupon payment = $100*5% = $5
FV = $100
Substituting the values in formula:
= -pv(4.01%,10,5,100)
= $108.03
We can calculate the purchase price by using the following formula in excel:-
=-pv(rate,nper,pmt,fv)
Here,
PV = Purchase price
Rate = 4.01%
Nper = 10-4 = 6 periods
Pmt = Coupon payment = $100*5% = $5
FV = $100
Substituting the values in formula:
= -pv(4.01%,6,5,100)
= $105.19
a). Cash flow at time 1-3 = $5
Cash outflow at time 0 = -$108.03 Or -$108
Total cash flow at time 4 = $105.19+$5 = $110.19 Or $110
b). Internal rate of return (IRR) = 4.01%
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