You have a planning horizon of H = 3 years and with to immunize your investment

Question

You have a planning horizon of H = 3 years and with to immunize your investment for that horizon. You attempt to do so by buying a perpetual bond that pays $100 annually and has a YTM of 20% p.a. You will reinvest the coupons throughout this 3-year period and, additionally, you will sell the bond at the end of that 3-year period. Find the total cash flow you will have 3 years from now if interest rates decrease to 19% just after you buy the bond, and then remain at that new level throughout your planning horizon. Give the answer with two decimals; e.g., 1,234.56. As always, do not include the dollar sign in your answer.

Explanation / Answer

Bond price = 100 / 0.2 = 500

Each year invest 100 at 19%

amount of coupons after 3 years = 100*((1+19%)3 - 1) / 19% = 360.61

Bond value after 3 years = 100 / 19% = 526.32

Cashflow = 360.61 + 526.32 = 886.93

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