- CFA Exams
- CFA Level I Exam
- Study Session 14. Fixed Income (1)
- Reading 44. Introduction to Fixed-Income Valuation
- Subject 1. Bond Prices and the Time Value of Money

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**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

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**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: 1000-816.54=183.46 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! |