K the market interest rate is 6 for similar bonds k

Info icon This preview shows pages 16–20. Sign up to view the full content.

View Full Document Right Arrow Icon
K The market interest rate is 6% for similar bonds K The price of the bond is $957.88 (see earlier example). K Now suppose that one year later, the yield-to-maturity for similar bonds has increased to 8%. K If an investor bought the bond one year ago at $957.88 and sells it now, what is his realized rate of return (ROR)? 64 . 900 $ ) 08 . 1 ( 000 , 1 08 . 0 ) 08 . 1 ( 1 50 4 4 1 = + ⎥ ⎦ ⎤ ⎢ ⎣ ⎡ − = PV ROR ! = 50 957.88 + 900.64 " 957.88 957.88 = 5.22% + ( " 5.98%) = " 0.76% current yield+ %capital loss What happened? Interest rate risk! * Computing the ROR like this only works for one time period. See next slide for more.
Image of page 16

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
16 Converting ROR Formula for a one Period Investment K FYI: This is for those who are curious how I got from the one definition of the ROR to the other one. K The general formula for calculating the ROR is PV*(1+ROR) n = FV. For a one-period investment, where all cash inflows occur at the end of the period, we can use algebra to get the equation that says the ROR is equal to the current yield +/- %capital gain/loss. Using the numbers from the previous example, this is the math that gets you from the general formula to the one-period formula. PV ! (1 + ROR ) n = FV 957.88(1 + ROR ) = 50 + 900.64 957.88 + 957.88 ! ROR = 50 + 900.64 957.88 ! ROR = 50 + 900.64 " 957.88 ROR = 50 957.88 + 900.64 " 957.88 957.88 = 5.22% + ( " 5.98%) = " 0.76%
Image of page 17
17 Example: ROR on Bond Investment (1) K You buy a corporate bond with 5 years to maturity. K The bond makes semi-annual coupon payments at a coupon rate of 8%. K You pay $852.80 for the bond, implying a ytm of 12% K You hold the bond to maturity while re-investing the coupon payments in a savings account that pays 2% per year compounded semi-annually. K What is your realized rate of return (ROR)? K Hint: Need something that looks like PV*(1+r) n = FV Or P B *(1+ROR) n = FV(all cash flows associated with holding bond)
Image of page 18

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
18 Example: ROR on Bond Investment (2) K Timeline: 0 1 2 3 4 5 6 7 8 9 10 Periods K ----|-----|-----|-----|-----|-----|-----|-----|-----|-----|-----|----- 40 40 40 40 40 40 40 40 40 40 1,000 K Want something that looks like K PV(1+ROR) n = FV K Or P B *(1+ROR) n = FV(all cash flows associated with holding bond) K What is the future value of the investment? Need FV of coupon payments using the re-investment rate of r semi = 1%: 4885 . 418 , 1 000 , 1 4885 . 418 000 , 1 01 . 0
Image of page 19
Image of page 20
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern