A 15-year bond of ₹5,00,000 that has a dividend rate of 5% per year, payable semiannually, is currently for sale. If the expected rate of return of the purchaser is 8% per year, compounded semiannually and if the inflation rate is expected to be 1.5% for each 6-month period, what is the bond worth

Question

A 15-year bond of ₹5,00,000 that has a dividend rate of [latex]5\%[/latex] per year, payable semiannually, is currently for sale. If the expected rate of return of the purchaser is 8% per year, compounded semiannually and if the inflation rate is expected to be [latex]1.5\%[/latex] for each 6-month period, what is the bond worth now (a) without an adjustment for inflation and (b) when inflation is considered?

Accepted Answer

(a) Without inflation adjustment: The semi-annual dividend is I = {(₹5,00,000)(0.05)}/2 = ₹12,500. At a nominal [latex] 4\%[/latex] per 6 months for 30 periods, the P.W. is:

[latex]P.W.=₹12,500\left(P/A,4\%,30\right)+₹5,00,000\left(P/F,4\%,30\right)[/latex]

[latex]=₹12,500\left(17.2920\right)+₹5,00,000\left(0.3083\right)[/latex]

[latex]P.W.=₹3,70,300[/latex]

(b) With inflation: Use the inflated rate [latex]i_{f}[/latex] :

[latex]i_{f}[/latex] = 0.04 + 0.015 + (0.04)(0.015) = 0.0556

[latex]P.W.=₹12,500\left(P/A,5.6\%,30\right)+₹5,00,000\left(P/F,5.6\%,30\right)[/latex]

[latex]=₹12,500\left(14.4079\right)+₹5,00,000\left(0.1970\right)[/latex]

[latex]P.W.=₹2,78,598,80[/latex]

Question 10.2: A 15-year bond of ₹5,00,000 that has a dividend rate of 5% p...

This Question has been Answered.

Already have an account?

Login

Related Answered Questions