Question

Suppose you purchase a​ ten-year bond with 9 % 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 8.05 % 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.

Answer 1

a). To find the purchase price of the bond, we need to put the following values in the financial calculator:

INPUT	10	8.05		9%*100=9	100
TVM	N	I/Y	PV	PMT	FV
OUTPUT			-106.36		So,

So, Purchase Price of the bond = $106.36

Now, we need to find the price at which the bond would be sold, for that we need to put the following values in the financial calculator:

INPUT	6	8.05		9%*100=9	100
TVM	N	I/Y	PV	PMT	FV
OUTPUT			-104.39

So, Sale Price of the bond = $104.39

So, We will pay $106.36 for bond purchase at year 0, i.e., CF0 = -106.36;

We receive annual coupon payments for Year 1 to 3 of $9, i.e., C01 = 9; F01 = 3;

then we sell the bond for $104.39 and receive a coupon payment of $9 at Year 4; i.e., C02 = 104.39 + 9 = 113.39; F02 = 1.

b). to find the IRR, we need to put the following values in the financial calculator:

CF0 = -106.36; C01 = 9; F01 = 3; C02 = 113.39; F02 = 1; Press IRR, then CPT. which gives 8.05

Hence, IRR for this investment = 8.05%