CFA Practice Question

There are 490 practice questions for this study session.

CFA Practice Question

Richard Gondus purchases a bond, but is concerned about his coupon interest, reinvestment income and capital gain. What is the total cash flow return that Edward earns, assuming a price of $816.54, coupon of 4.50%, four year maturity and a market interest rate of 10.20%?
A. $399.08
B. $250.40
C. $254.25
Explanation: The total cash flow return includes the coupon interest, capital gain and reinvested interest. This is essentially a future cash flow question.

Analysts should first determine the market interest rate and number of periods. After computing the future cash flows of a lump sum, analysts need to remember to subtract the initial purchase price to arrive at the total cash flow return. The detailed solution follows:
Total cash flow return of $399.08
Price of bond =$816.54
Number of Periods = 4.00 * 2= 8.00
Market interest = 10.20%/2 = 5.10%
Solve for Future Value =$1,215.62
Subtract the initial purchase price of $816.54 = $399.08

User Contributed Comments 13

User Comment
Wiliam313 How the hell that I know the bond is semi-annual paid.
johnsk that's the convention unless you are otherwise told, Wiliam313.
Pooh In order to calc FV to be 1,215.62, PMT must be zero on the calculator. But the question stated the coupon rate 4.5% (assumed it's the annual rate), shouldn't the coupon rate be considered in the calculation? PMY = 4.5/2=2.25? Thus, the FV would be 1,172.49 and the answer would be 355.96. Anyone?
danlan Suppose all coupon are reinvested with the market interest rate
semra thanks danlan
lazio I don't understand why the market interest rate is divided by 2. Can someone help?
Xocrevilo Lazio: the market interest rate needs to be semi-annualized, so split in two. This is simply a convention that we have to follow for answering CFA questions in the industry.

Pooh: I strongly agree with you, and cannot understand why the coupon is being ignored here.

MFTIOA the annuity of the coupon payments + capital gain on the bonds
micheleus coupon is not ignored.

calculate FV from reinvest coupon: N=8 I=10.2%/2 PV=0 PMT=4.5%x1000/2=22.5 ---> CPT FV = 215.62

Totlal cashflow return= (1000 + 215.62)- 816.54 = 399.08
eboyd The question says Mr. Gondus is concerned with coupon payments, reinvestment income, and capital gain. Therefore, I solved the problem by first computing the coupon payments and reinvestment income:

Using BAII Plus:
N=8 I/Y=5.1 PV=0 PMT=22.5 --> CPT FV=-215.62

Then, the capital gain must be the face value minus the purchase price:

So, the total coupon, reinvestment, and gain equals: 215.62 + 183.46 = 399.08
jpducros Thanks eboyd, I like your way...
meeravenk Thanks micheleus and eboyd!
langy Thanks micheleus and eboyd... exactly what I was looking for!
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