Question

Compute both the Total ROR and the Annualized Rate of Return for the bond.

You buy the following bond and you hold until maturity.

2 year bond - Coupon = 6% and Yield = 6% and Reinvestment rate = 4%

Compute both the Total ROR and the Annualized Rate of Return for the bond.

Answer 1

Assuming the par value to be $100

Future cash flows are the following:

Year 1	$6
Year 2	$106

The reinvestment rate is 4%

So the year 1 CF will be reinvested at 4% and becomes at year 2 = 6*1.04 = $6.24

So total CF recived at the end of year 2 by the investor is = 106 + 6.24 = $112.24

Now ROR is return obtained on inital investment = (112.24-100)/100 = 12.24%

Annaulized rate of return is the CAGR or coumpoud interest = (112.24/100)^(1/2) - 1 = 5.943%