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

Expansion financing, The securing of the working capital needed for the sup...

The securing of the working capital needed for the support of raises in accounts receivable and inventory related with an organizations initial expansion time.

Explain gresham’s law, Explain Gresham’s Law. Answer:  Gresham’s law cons...

Explain Gresham’s Law. Answer:  Gresham’s law considers to the phenomenon that bad (abundant) money drives good (scarce) money out of circulation. This type of phenomenon was fre

Define discounting the cash flows in the apv model, What is the intuition o...

What is the intuition of discounting the several cash flows in the APV model at fixed discount rates? The APV model is a value-additivity method where total value is defined by t

Cash flow estimation and risk ananlysis.., as a financial analyst, you must...

as a financial analyst, you must evaluate a proposed project to produce printer ink. the equipment would cost 60000 plus 10000 for installation. annual sales would be 5000 units at

Yield to call, Yield to call is the yield that would be realized on a...

Yield to call is the yield that would be realized on a callable bond assuming the issuer of the bond redeems it before maturity. A bond's call provision is detail

Types of orders prevalent in the us markets, The following are various type...

The following are various types of orders prevalent in the US markets: Market Order : The most common form of order is the market order, which means the order to buy or sell at

Determine the financial requirements of the business, Q. Determine the fina...

Q. Determine the financial requirements of the business ? Decisive the Financial Needs: - The initial task of the financial management is to estimate and determine the financia

Determine the fields of finance, Determine the Fields of Finance Academ...

Determine the Fields of Finance Academic discipline of financial management may be viewed as made up of five specialized fields. In every field, financial manager is dealing wi

Define in- order-driven according to trade intermediation, Define the in- o...

Define the in- order-driven according to trade intermediation. In- order-driven markets: In order-driven markets, buyers and sellers trade unswervingly without any intermedi

Calculate the interest value , 1. Suppose a firm's tax rate is 35%. What af...

1. Suppose a firm's tax rate is 35%. What affect would a $10 million operating expense have on this year's earnings?  What effect would it have on next year's earnings? 2. What

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