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 increase to 21% 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

Year 1 Year 2 Year 3 Inflow 100 100 100 Reinvestment -100 Income from investment 21 21 Reinvested -21 Income from investment 4.41 Reinvestment -100 Income from investment 21 Value of the Bond      697.19 Total Inflow 0 0 843.60 Caculation of Value of Bond Price of the bond=c/r C=100+21+4.41+21 146.41 r= 21% Value of the Bond 146.41/21%          697.19

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