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Suppose that an investor has 8 years investment horizon. The investor is considering a 20-year semi-annual coupon bond selling at par and having a coupon rate of 10%. The investor expectations are as follows:
The first 6 semi-annual coupon payments can be reinvested from the time of receipt to the end of the investment horizon at an annual interest rate of 7%.
The remaining semi-annual coupon payments can be reinvested from the time of receipt to the end of the investment horizon at a 11% annual interest rate.
Investor believes that the required return on a 12-year bond of this quality at the end of the investment horizon will be 12%.
(a) Calculate the total return on bond equivalent basis?
(b) What is the total return on effective rate basis?
