7.28.2005

Q&A: What is the reinvestment income if...

...an investor holds a 14.00%, 17.50 year bond bought at $950.00 to maturity, with the market interest rate at 15.00%?

  • FV of total cash flows = PV * (1+r)^N = $950.00 * (1+15/2/100)^(17.50*2) = $11940.43
  • Coupon Interest Payments = 14% * $1000 * 17.50 = $2,450.00
  • Capital gain/loss = $1000 - 950.00 = $50.00
  • Reinvested interest = total cash flow return - Coupon Interest Payments - Capital gain/loss = FV of total cash flows - Purchase price - Coupon Interest Payments - Capital gain/loss = $11940.43 - $950 - $2,450.00 - $50.00 = $8490.43

Bonus Points

  • In additon to reinvestment income, two other sources of income from holding a bond to maturity are coupon interest and capital gain/loss (when matures/called/sold)
  • Reinvested interest is also known as "interest on interest".
  • Two factors that affect the degree of reinvestment risk:
    • maturity: the longer the maturity, the higher the reinvestment risk
    • coupon rate: the higher the coupon rate, the higher the reinvestment risk. This implies that premium bond will be more dependent on reinvestment income than a bond selling at par.

Category: C++ Quant > Debt > Valuation

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