Question

(Bondholders' expected rate of return) Zenith Co.'s bonds mature in 14 years and pay 9 percent interest annually. If you purchase the bonds for $950, what is your expected rate of return? Your expected rate of return is %. (Round to two decimal places.)

Answer 1

To calculate the expected rate of return for a bond, include both annual interest payments and the capital gain or loss. For Zenith Co.'s bond, which pays 9% annual interest and was purchased for $950, the expected rate of return is 9.85% when it matures in 14 years.

Step-by-step explanation:

To calculate the expected rate of return on Zenith Co.'s bonds, we need to consider both the annual interest payments and the capital gain or loss on the investment.

Each year, the bond pays 9% of the $1000 face value, which equals $90 in interest. Over 14 years, these payments total $1260. Additionally, since you purchase the bonds for $950 and they will mature at $1000, there is a capital gain of $50 over the life of the bond.

To find the expected rate of return, we use the formula:

Expected Rate of Return = (Annual Interest Payment + (Face Value - Purchase Price) / Investment Period) / Purchase Price

Plugging in the values, we get:

Expected Rate of Return = ($90 + ($1000 - $950) / 14) / $950

Expected Rate of Return = ($90 + $3.57) / $950

Expected Rate of Return = $93.57 / $950

Expected Rate of Return = 0.09849 or 9.85% when rounded to two decimal places.

Thus, your expected return would be 9.85% if you were to purchase Zenith Co.'s bonds for $950.