Question

You paid $10,000 for an investment that promises to pay $750 at the end of each of the next 5 years, then an additional lump sum payment of $10,000 at the end of the 5th year. What is the expected rate of return on this investment? Discuss.

a. 12.39%.b. 15.23%.c. 12.91%.d. 11.49%.e. 10.46%.

Answer 1

7.50%

Step-by-step explanation:

The formula to solve this problem is stated below.

`p=(A(1-(1+r)^(-n) )/(r) + (F)/((1+r)^(n) )`

where p = price paid = $10,000

A = annual coupon payment = $750

n = tenor = 5 years

F = face value paid at maturity = $10,000

r, the unknown = rate of return.

Using extrapolation, the value of r that resolves the problem = 7.5%. The is expected since the price of the bond is the same as face value. As such, the rate of return was the same as
`(A)/(p)=(750)/(10,000)` = 7.5%.

`10,000=(750(1-(1.075)^(-5) )/(0.075) + (10,000)/((1.075)^(5) )`.