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

Consigner for safe transportation of dangerous goods, Q. Consigner for safe...

Q. Consigner for safe transportation of dangerous goods? It is the responsibility of the consigner to ensure the following, 1. The goods carriage should have a valid registr

Calculate the net present value-investment proposal, As you checked the Ans...

As you checked the Answer Key to Question 6 in the Mastery Check from this lesson you may have noted that each year's net cash flows are calculated by adding depreciation back to n

State about the equity owners, State about the equity owners Flip side...

State about the equity owners Flip side of the coin is that the equity owners are also owners of all the profits which remain after all the debt holders are paid their interes

Management of pension funds, Management of pension funds Employees Prov...

Management of pension funds Employees Provident Fund Organization (EPFO) is the major organization which deals with the pension system in India. The Employees' Provident Fund O

Find NPV of 2 Projects, Woody Construction is considering a new 3-year expa...

Woody Construction is considering a new 3-year expansion project that requires an initial fixed asset investment of $3.186 million. The fixed asset will be depreciated straight-lin

Illustrate the zero bonds security instruments, Illustrate the zero bonds s...

Illustrate the zero bonds security instruments. Zero coupon bonds are instruments under that a borrower promises, at the recent time, to pay one exact nominal sum (face value)

Segment margin, Segment Margin This is the amount in which a business s...

Segment Margin This is the amount in which a business segment in a company contributes toward the common or indirect cost of the company. Therefore, it represents that segment'

Define the meaning of rate of return on investment, Define the meaning of r...

Define the meaning of rate of return on investment An investment project which provides positive NPV when its cash flows are discounted by cost of capital makes a net contribut

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