Question

You paid $10,000 for an investment that promises to pay $750 at the end of each of the next 5 years, then an additional lump sum payment of $10,000 at the end of the 5th year. What is the expected rate of return on this investment? Discuss.
a. 12.39%.b. 15.23%.c. 12.91%.d. 11.49%.e. 10.46%.

Answer 1

Answer:

7.50%

Explanation:

The formula to solve this problem is stated below.

$p=\frac{A(1-(1+r)^{-n} }{r} + \frac{F}{(1+r)^{n} }$

where p = price paid = $10,000

A = annual coupon payment = $750

n = tenor = 5 years

F = face value paid at maturity = $10,000

r, the unknown = rate of return.

Using extrapolation, the value of r that resolves the problem = 7.5%. The is expected since the price of the bond is the same as face value. As such, the rate of return was the same as $\frac{A}{p}=\frac{750}{10,000}$ = 7.5%.

$10,000=\frac{750(1-(1.075)^{-5} }{0.075} + \frac{10,000}{(1.075)^{5} }$.