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

What are the main flaws of the profit maximisation criterion, What are the ...

What are the main flaws of the profit maximisation criterion The main technical flaws of this criterion are i) ambiguity, ii) quality of benefits and iii) timing of be

Why is the replacement value of assets method, Why is the replacement value...

Why is the replacement value of assets method not generally used to value complete businesses? The replacement value of assets method isn't often applied to entire business val

Portfolio management a financial tool for a firm''net worth, I need your...

I need your assistance on how to group the relevant data so as to help me in the data analysis

182-day t-bills, 182-Day T-Bills Following the Sukhamoy Chakravarty Com...

182-Day T-Bills Following the Sukhamoy Chakravarty Committee recommendations, in November, 1986, 182-day T-bills were introduced in order to develop the short-term money market

Microsoft''s Partenership Strategies, I have a presentation to give on ''Ne...

I have a presentation to give on ''New ways'' Microsoft can improve its ''Partnership Strategies''. Can some one please give some good links or insights into the same.

Calculate the net premium retrospective reserve value, Question: On 1st...

Question: On 1st October 2001 a man then aged 34 took out an endowment assurance policy with a sum assured of $100,000 payable on survival to age 50 or at the end of the year o

Financial projections, A total of $426,000 seed-funding would be ideal to s...

A total of $426,000 seed-funding would be ideal to start the project on a local basis. The cost analysis done above is for the material required to perform the work, and as the wor

Public finance, suppose perfect competition prevails in the market for hote...

suppose perfect competition prevails in the market for hotel rooms. the current market equilibrium price of a stanar hotel room is 100 per night

Explain why accounting profits and cash flows are different, Explain why ac...

Explain why accounting profits and cash flows are not the same thing. Ans: Stock value relies on future cash flows, their timing, and their riskiness.  Profit calculations do 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

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