26 Jul WHY DOES THE REINVESTMENT RATE AFFECT THE ANNUAL RATE OF RETURN FOR THE SAME BOND?
You have been hired to analyze the debt securities of your organization. The firm has outstanding lo Show more You have been hired to analyze the debt securities of your organization. The firm has outstanding loans and bonds. A quick review of the balance sheet shows the following: Liability Amount ($) Nominal Interest (coupon) Rate Years to Maturity Selected Liabilities of the firm Selected Liabilities of the firm Selected Liabilities of the firm Selected Liabilities of the firm Simple Loans 800 5% 1 Fixed-Payment Loans 5000 12% 19 Long-term Bonds #1 500000 10% 4 Long-term Bonds #2 1080000 10% 10 Liabilities Total 1585800 Market Price for Bond #1 930.50 Market Price for Bond #2 859.50 Face Value of Each Bond 1000.00 Selected Current Assets of the firm Selected Current Assets of the firm Selected Current Assets of the firm Selected Current Assets of the firm Marketable Securities: Treasury Bills 100000 Note: Treasury Bills have a $10000 face value which matures in one year. Each Treasury Bill has a cost of $9580.00 1-How much interest would the firm pay each year on the simple-interest loan? 2-How much would you write a cheque for to pay off the loan in one year? 3-What is the monthly payment needed to pay off the fixed-payment loans? 4-What is the current yield for each bond if the current price is: a-$930.50 for Bond #1? b-$859.50 for Bond #2? 5-What is the expected yield to maturity for each bond? a-Bond #1 selling for $930.50? b-Bond #2 selling for $859.50 6-What is the rate of capital gain if both bonds sell for $900.00 in one year? a-Bond #1 selling for $930.50 today? b-Bond #2 selling for $859.50 today? 7-If the Yield to Maturity expected by investors changes to 11%: a-What will be the market price of Bond #1? b-What will be the market price for Bond #2? c-What will be the dollar change in price for Bond #1? d-What will be the dollar change in price for Bond #2? e-What will be the percent change in price for Bond #1? f-What will be the percent change in price for Bond #2? g-Since the change in expected yield to maturity is the same why is the amount of change different between the bonds? 8-If investors holding our 4-year bonds (Bond #1) receive interest income annually for four years plus the face value of the bonds at maturity a-What will be the total interest earned on the bond over the next four years? b-What will be the face value received at maturity? Given the following projected income stream for Bond #1: Projected Reinvestment Rates Projected Reinvestment Rates Year Coupon Interest ($) Face Value ($) 10% 5% 1 100 2 100 10.00 5.00 3 100 21.00 10.25 4 100 1000 33.10 15.76 Total Income 400 1000 64.10 31.01 c-What is the total cash available over the next four years to the bond holder earning ii-10% iii-15% d-What is the average annual rate of return for the bond holder earning ii-10% iii-15% e-Why does the reinvestment rate affect the annual rate of return for the same bond? f-If the expected rate of return on our bonds is 10% what is the duration of Bond #1? Show less
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