Question bond math
Can anyone help me out with this question please? Thanks!
An investor buys a 4 year, 4.375% annual coupon payment bond at 102 (percent of par value), collects the first coupon and reinvests at 2.25% for the second year, and then reinvests those proceeds along with the receipt of the second coupon at 2.50% for he third year. The investor then sells the bond at a price of 101 (percent of par value) immediately after collecting the third coupon payment. The horizon yield on the bond, i.e., annual holding-period rate of return over the three years, is closest to:
a) 3.912% b) 4.815% c) 3.878% d) 3.815%
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Y0 CF = -102 Y1 CF = 0 Y2 CF = 0 Y3 CF = 101 + 4.375 + 4.375 * (1 + 2.5%) + 4.375 * (1 + 2.5%) * (1 + 2.25%) Run Excel and calculate the IRR. It's 3.912%.
And no, the question is not impossible, it's just basic math...
We monkeys know how to move logos around though.
How come you didn't discount the $101 principal that was sold after Y3?
Yes, we do discount that 101. It's called calculating the IRR.
For Y3 CF, why is it 101 + 4.375 + 4.375 * (1 + 2.5%) + 4.375 * (1 + 2.5%) * (1 + 2.25%) and not 101 + 4.375 + 4.375 * (1 + 2.25%) + 4.375 * (1 + 2.25%) * (1 + 2.5%)?
The 1st coupon of 4.375 will become 4.375 * (1 + 2.25%) * (1 + 2.5%). The 2nd coupon will become 4.375 * (1 + 2.5%).
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