- CFA Exams
- CFA Level I Exam
- Topic 1. Quantitative Methods
- Learning Module 2. Time Value of Money in Finance
- Subject 2. Fixed Income Instruments and the Time Value of Money
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.
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
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: 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! |