In: Finance
Assume you buy a bond with the following features
Bond maturity = 4
Coupon Rate = 3%
Face Value = $1,000
Annual Coupons
When you buy the bond the market interest rate = 4.76%
Immediately after you buy the bond the interest rate changes to
6.67%
What is the "reinvestment" effect in year 3 ?
Can you show me how to do it step by step in a financial calculator?
Coupon per period = Coupon rate * Face value
Coupon per period = 3% * $1000
Coupon per period = $30
Future value of coupons at the end of year 3 if reinvested at market rate of 6.67%
Future value at 6.67% = Coupon * ((1 + interest rate)no of periods - 1) / interest rate
Future value at 6.67% = $30 * (1 + 6.67%)3 / 6.67%
Future value at 6.67% = $96.1365
Using Texas BA 2 plus Calculator
N = 3, PV = 0, PMT = -30, I/Y = 6.67
CPT --> FV = 96.1365
(Make sure that 2nd + BGN is set as END)
Future value of coupons at the end of year 3 if reinvested at market rate of 4.76%
Future value at 4.76% = Coupon * ((1 + interest rate)no of periods - 1) / interest rate
Future value at 4.76% = $30 * (1 + 4.76%)3 / 4.76%
Future value at 4.76% = $94.3520
Using Texas BA 2 plus Calculator
N = 3, PV = 0, PMT = -30, I/Y = 4.76%
CPT --> FV = 94.3520
Reinvestment affect = Future value at 6.67% - Future value at 4.76%
Reinvestment affect = $96.1365 - $94.3520
Reinvestment affect = $1.7845