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
What is a callable bond?  What is a putable bond?  How do each of these features affect their respective market interest rates? A callable bond may be retired untimely at the dis

Management Accounting: Management accounting on the other hand tends to focus internally. Reports generated through management accounting processes will be used by the organisa

Chu Chu Train Systems is expected to pay a $3.25 annual dividend (D1 = $3.25), the dividend is expected to grow at a constant rate of 5.50% a year, and the common stock currently s

Determination of spread Daily interest rate = 5.11/ 365 = 0.014% per day Variance of cash flows = 1000 × 1000 = $1000000 per day Transaction cost = $18 per transaction

Q. Describes Net Income Approach to Capital Structure? Net Income Approach: - As-per to the Net Income Approach as suggested by Durand the capital structure decision is applica

Determine about the Zero Interest Bonds (ZIBs) Very much alike DDBs, only crucial difference is that these are issued at face values (DDBs are issued at a discount to face valu

Assume that the treasurer of a company has an extra cash reserve of $1,000,000 to invest for six months. The six-month interest rate is 8% per year in the U.S. and 6% per year in G

Explain the meaning of - Purchase consideration The  type  of  offer  made  to  target  company's  shareholders  would have  a  big  impact on acceptance. Apparently the price

Setting Budget Goals and Objectives: Having collected and analysed all relevant information, and made general forecasts as to the key areas of concern / opportunity and special