Question

In: Finance

Assume you buy a bond with the following features Bond maturity = 4 Coupon Rate =...

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?

Solutions

Expert Solution

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


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