Computing the expected total return for investment, Financial Management

Assignment Help:

To compute the total returns we need the investment horizon, reinvestment rate and the price of the bond at the end of the investment horizon. Steps involved in computing total return over the investment horizon are as follows:

  1. First, we need to compute the total coupon payments and the reinvestment income based on an assumed reinvestment rate. Reinvestment income is the amount that can be earned by reinvesting the coupon interest received on the securities. Mostly, bond interest is paid semiannually; so let us assume that the coupon payment is reinvested every six months. Therefore, the reinvestment rate can be calculated by dividing the annual interest rate that the investor assumes can be earned by reinvestment with two.

  2. Next, we need to determine the projected sale price at the end of the investment horizon. This is referred to as horizon price.

  3. By adding the value computed in (i) and (ii) and deducting the cost to obtain the funds we arrive at total future return that will be received from the investment. The reinvestment rates are assumed.

  4. Then we need to calculate semiannual total return using the formula

(Total future return/ full price of the bond) 1/n - 1

Full price is obtained by adding accrued interest to the price. And n is the number of semiannual periods in the investment horizon.

  1. The total return for semiannual-pay bonds can be expressed on a bond-equivalent basis by simply doubling the interest rates found in step 4.To express the total returns on an effective rate basis - the formula used is(1 + Semiannual total return) 2 -1.

The total return can either be calculated on a bond-equivalent basis or on an effective rate basis. If the total returns are compared to a benchmark index that is based on bond-equivalent basis, then the total return is also to be calculated on the basis of bond-equivalent. But if liabilities are calculated on an effective rate basis and the bond is being used to satisfy liabilities, then the total return should be calculated on the basis of effective rate.


Related Discussions:- Computing the expected total return for investment

Cost of capital, Provide an argument for including or not current liabiliti...

Provide an argument for including or not current liabilities in the cost of capital calculation.

State the term- dividend cover, Dividend cover Dividend cover = Profit ...

Dividend cover Dividend cover = Profit available to ordinary shareholders (PAT) / Annual dividend(no. of times) Or =    EPS/Dividend per share Dividend cover shows safety

What is the time value of money, What is the time value of money? The t...

What is the time value of money? The time value of money signifies that money you hold in your hand today is worth more than money you expect to receive in the future. Likewise

Deefine market price of a bond be influenced, If all other things held cons...

If all other things held constant, how would the market price of a bond be influenced if coupon interest payments were made semiannually in place of annually? Several bonds iss

Define primary advantage to a corporation of investing, What is the primary...

What is the primary advantage to a corporation of investing some of its funds in working capital? By investing in working capital a firm acquires the liquidity it requirements he

Factors considered in assigning a credit rating, Credit rating agenci...

Credit rating agencies carry out credit rating. Companies appoint these agencies to assign credit rating for their corporate issues. The rating agencies may condu

Personal finance chapter 9 workbook 2nd edition, answers for the personal f...

answers for the personal finance literacy 2nd edition workbook answers chapter 9(obtaining and protecting your credit)

Company default rate on account receivable when its too low, Can a company ...

Can a company have a default rate on its accounts receivable that is too low?  Explain. A company might have a default rate on AR that would be considered too low if by liberal

LPP, A paper mill produces two grades of paper viz., X and Y. Because of ra...

A paper mill produces two grades of paper viz., X and Y. Because of raw material restrictions, it cannot produce more than 400 tons of grade X paper and 300 tons of grade Y paper i

Asset-backed and mortgage-backed securities, When financial assets or bonds...

When financial assets or bonds are pooled together and offered to the investors for receiving the inflow of funds from these underlying assets, they are termed as asset

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd