How to calculate rate of return?, Financial Management


Consider a Rs.1,000 par value bond whose current market price is Rs.850. The bond carries a coupon rate of 8% and has a maturity period of 9 years. What would be the rate of return that an investor earns if he purchases the bond and holds till maturity?


The rate of return earned, also referred to as yield to maturity, is the value of kd in the following equation:

         P0               =     1034_rate of return.png

         Rs.850          =     821_rate of return1.png

                            =     Rs.80 (PVIFAkd%, 9 yrs) + Rs.1,000 (PVIFkd%, 9 yrs.).


         I        =   Interest

         F       =   Face value

         kd      =   Cost of debt

         P0      =   Current market price.

To find out the value of kd in the above equation, several values of kd will have to be tried out in order to reach the input value. Therefore, to start with, consider a discount rate of 12% for kd for which the expression becomes equal to:

         = Rs.80 (PVIFA 12%, 9 yrs) + Rs.1,000(PVIF12%, 9 yrs.)

         = Rs.80 x 5.328 + Rs.1,000(0.361)

         = Rs.426.24 + Rs.361 = Rs.787.24.

Since the above, value is less than the market price, we have to try with a less discounting rate (kd). So, let kd = 10%, then the equation becomes:

         = Rs.80(PVIFA10%, 9 yrs.) + Rs.1,000 (PVIF10%, 9 yrs.)

         = Rs.80 x 5.759 + Rs.1,000 x 0.424

         = Rs.460.24 + Rs.424 = Rs.884.72

From the above, it is clear that kd lies between 10% and 12%. Now, we have to use linear interpolation in the range of 10% and 12%. kd is determined as follows:


2292_rate of return2.png

                        = 10% + (12 - 10%)   2245_rate of return3.png   


                   = 10% + 2% 1276_rate of return4.png


                   = 10% + 2% x 0.356

                   = 10% + 0.71

                   = 10.71%

The yield to maturity is 10.71%.

An Approximation: As trial and error methods of calculation are tedious, the following approximation formula can be employed to find out the approximate YTM on a bond.


         YTM = 699_rate of return5.png       



           YTM          =     Yield to maturity.

                   I       =     Annual interest payment.

                   F       =     Par value or redemption value of the bond.

                   P       =     Current market price of the bond.

                   N       =     Years to maturity.



         YTM =         1053_rate of return6.png

                            615_rate of return7.png

Posted Date: 9/10/2012 1:43:38 AM | Location : United States

Related Discussions:- How to calculate rate of return?, Assignment Help, Ask Question on How to calculate rate of return?, Get Answer, Expert's Help, How to calculate rate of return? Discussions

Write discussion on How to calculate rate of return?
Your posts are moderated
Related Questions
Principal repayment before the scheduled date is called a prepayment. Every individual borrower normally has the option to pay off all or part of their loan

Q. Foreign exchange - Maximum loss? From Marton's point of view an adverse outcome is depreciation of the dollar against sterling as this lowers its income when converted into

Explain how exchange rate fluctuations influence the return from a foreign market measured in dollar terms. Discuss the empirical proof on the effect of exchange rate doubt on the

Compare and contrast the various types of secondary market trading structures.  Answer:  There are two major types of secondary market trading structures:  dealer and agency.  I

Calculate the Operating Cashflows from 2007 - 2011 using the indirect method to add back depreciation. Suppose that depreciation will grow at the similar rate as sales.

What is logistics? Explain the important activities in logistics systems. Logistics - meaning . Working of logistics systems - three important activities - Order processing, I

Q. Define Finance Function and discuss its nature and scope Ans. Meaning of Finance: - Finance is defined as the provision of funds at the time when it is required. The role of

Identify and describe three types of start ups firms. Give an example of one you have dealt with. What is a business plan, what are its major components, and why is it important

Pros and Cons Simulation technique allows experimentation with a model of the real life system. Whenever experimenting with the system itself is risky and/or costly, simulation

Do you guys provide Working Capital Financing assignment help? I need writing a report on Working Capital Financing and it is about 2000 words. Let me know. I need to buy your solu