Computing the expected total return for investment, Financial Management

To compute the total returns we need the investment horizon, reinvestment rate and the price of the bond at the end of the investment horizon. Steps involved in computing total return over the investment horizon are as follows:

  1. First, we need to compute the total coupon payments and the reinvestment income based on an assumed reinvestment rate. Reinvestment income is the amount that can be earned by reinvesting the coupon interest received on the securities. Mostly, bond interest is paid semiannually; so let us assume that the coupon payment is reinvested every six months. Therefore, the reinvestment rate can be calculated by dividing the annual interest rate that the investor assumes can be earned by reinvestment with two.

  2. Next, we need to determine the projected sale price at the end of the investment horizon. This is referred to as horizon price.

  3. By adding the value computed in (i) and (ii) and deducting the cost to obtain the funds we arrive at total future return that will be received from the investment. The reinvestment rates are assumed.

  4. Then we need to calculate semiannual total return using the formula

(Total future return/ full price of the bond) 1/n - 1

Full price is obtained by adding accrued interest to the price. And n is the number of semiannual periods in the investment horizon.

  1. The total return for semiannual-pay bonds can be expressed on a bond-equivalent basis by simply doubling the interest rates found in step 4.To express the total returns on an effective rate basis - the formula used is(1 + Semiannual total return) 2 -1.

The total return can either be calculated on a bond-equivalent basis or on an effective rate basis. If the total returns are compared to a benchmark index that is based on bond-equivalent basis, then the total return is also to be calculated on the basis of bond-equivalent. But if liabilities are calculated on an effective rate basis and the bond is being used to satisfy liabilities, then the total return should be calculated on the basis of effective rate.

Posted Date: 9/11/2012 1:46:40 AM | Location : United States







Related Discussions:- Computing the expected total return for investment, Assignment Help, Ask Question on Computing the expected total return for investment, Get Answer, Expert's Help, Computing the expected total return for investment Discussions

Write discussion on Computing the expected total return for investment
Your posts are moderated
Related Questions
Will you please give the defination of "Future Value Of An Annuity"?

The Total Investable Capital Market Portfolio According to a report prepared by McKinsey in January 2007, World financial assets including bonds, stocks, corporate debt securit

Meaning merits nd demerits of modern approch of financial management

Stock Exchange of Hong Kong Securities trading in Hong Kong started in 1866; however, the first formal stock market, the Association of Stockbrokers in Hong Kong, was establish

What happens to the riskiness of a portfolio if assets with very low correlations (even negative correlations) are combined? How successfully diversification decreases risk reli


Demerits of Pay Back Method:- (i) It ignores the Cash Flows after the Pay Back Period: - The main shortcoming of this method is that it completely ignores all cash inflows subs

using the operating cycle and any other financial management knowledge,discuss the applicabilty of such cycle to poultry

As liberalization is gathering momentum, corporate treasures and merchant bankers are in the process of devising new products to suit the needs of investors and c

Q. What is Allocation Registers? The object of allocation register is keep the heads of department of divisions districts and regions informed of the progress of expenditure by