In: Finance
Suppose an investor can purchase a 6-year 9% coupon bond with a par value of $100 that pays interest semi-annually. The yield to maturity for this bond is 10% on a bond-equivalent yield basis. What is the coupon interest, capital gain/loss and reinvestment income associated with this bond over its 6-year life? Assume that the reinvestment rate is equal to the yield to maturity.
Given
Coupon Rate = 9% per anum paid semi annually
Tenure of the Bond = 6 Years
Frequency of the coupon = Semi Annual
Yield to Maturity = 10%
Face Value of the bond = 100 dollars
(1) CALCULATION OF COUPON INTEREST
Coupon Interest = Principal Amount * Coupon Rate = 100*9% = 9 dollars per anum
But it is given that coupon is paid semi annually so Coupon for Half year = 9/2 = 4.5 dollars.
(2) CALCULATION OF CAPITAL GAIN OR LOSS
In order to find whether it is capital gain ir loss, first we have to find the purchase price of the bond which can be found by using following formula
Price of the bond = C1/(1+YTM)^1 + C2/(1+YTM)^2 + C3/(1+YTM)^3 + ............ +Cn/(1+YTM)^n + MV/(1+YTM)^n
C = Coupon on the bond = 4.5
YTM = Yield to Matuirty= 10% per anum = 5% Half Yearly
n = Number of periods = 10*2 = 20 (Since it is Semi Annual)
MV = Maturity Value = 100
Number of Periods | Coupons(A) | YTM@5%(B) | Present value of Coupons (A*B) |
1 | 4.5 | 0.952381 | 4.285714286 |
2 | 4.5 | 0.907029 | 4.081632653 |
3 | 4.5 | 0.863838 | 3.887269193 |
4 | 4.5 | 0.822702 | 3.702161137 |
5 | 4.5 | 0.783526 | 3.525867749 |
6 | 4.5 | 0.746215 | 3.357969285 |
7 | 4.5 | 0.710681 | 3.198065986 |
8 | 4.5 | 0.676839 | 3.045777129 |
9 | 4.5 | 0.644609 | 2.900740123 |
10 | 4.5 | 0.613913 | 2.762609641 |
11 | 4.5 | 0.584679 | 2.631056801 |
12 | 4.5 | 0.556837 | 2.505768382 |
13 | 4.5 | 0.530321 | 2.386446078 |
14 | 4.5 | 0.505068 | 2.272805788 |
15 | 4.5 | 0.481017 | 2.164576941 |
16 | 4.5 | 0.458112 | 2.061501849 |
17 | 4.5 | 0.436297 | 1.963335094 |
18 | 4.5 | 0.415521 | 1.869842947 |
19 | 4.5 | 0.395734 | 1.780802807 |
20 | 104.5 | 0.376889 | 39.38495096 |
Price of the Bond Now | 93.76889483 |
Capital Gain = Maturity Value - Purchase Price = 100-93.7689 = 6.2311 Dollars
(3) CALCULATION OF REINVESTMENT INCOME
Number of Periods | Coupons and Principal(A) | Number of Periods Coupon is reinvested | Yield at 5% (B) | Future Value of Coupons(A*B) |
1 | 4.5 | 19 | 2.526950195 | 11.37127588 |
2 | 4.5 | 18 | 2.406619234 | 10.82978655 |
3 | 4.5 | 17 | 2.292018318 | 10.31408243 |
4 | 4.5 | 16 | 2.182874588 | 9.822935648 |
5 | 4.5 | 15 | 2.078928179 | 9.355176807 |
6 | 4.5 | 14 | 1.979931599 | 8.909692197 |
7 | 4.5 | 13 | 1.885649142 | 8.48542114 |
8 | 4.5 | 12 | 1.795856326 | 8.081353467 |
9 | 4.5 | 11 | 1.710339358 | 7.696527112 |
10 | 4.5 | 10 | 1.628894627 | 7.33002582 |
11 | 4.5 | 9 | 1.551328216 | 6.980976972 |
12 | 4.5 | 8 | 1.477455444 | 6.648549497 |
13 | 4.5 | 7 | 1.407100423 | 6.331951902 |
14 | 4.5 | 6 | 1.340095641 | 6.030430383 |
15 | 4.5 | 5 | 1.276281563 | 5.743267031 |
16 | 4.5 | 4 | 1.21550625 | 5.469778125 |
17 | 4.5 | 3 | 1.157625 | 5.2093125 |
18 | 4.5 | 2 | 1.1025 | 4.96125 |
19 | 4.5 | 1 | 1.05 | 4.725 |
20 | 104.5 | 0 | 1 | 104.5 |
Reinvestment Income at the end of 20 th year | 248.7967935 |