You buy a very risky bond that promises a 9.5% coupon and return of the $1,000 principal in 10 years. You pay only $500 for the bond. You receive the coupon payments for 3 years and then the bond defaults. After liquidating the firm, the bondholders rece4ive a distribuion of $150 per bond at the end of 3.5 years. What is the realized return on your investment?
To calculate the realized return on your investment, we need to consider the cash flows received and the purchase price of the bond. Here's how you can calculate it:
1. Calculate the total cash flows received:
- For the first 3 years, you receive coupon payments of 9.5% of the principal ($1,000) for each year, which amounts to $95 per year. So, the total coupon payments received for 3 years is $95 * 3 = $285.
- At the end of 3.5 years, you receive a distribution of $150 per bond.
2. Determine the total cash invested:
- You paid $500 to purchase the bond.
3. Calculate the realized return using the formula:
Realized Return = (Total Cash Flows Received - Total Cash Invested) / Total Cash Invested
Applying these calculations, the realized return is:
Realized Return = (($285 + $150) - $500) / $500
= $435 / $500
= 87%
Therefore, the realized return on your investment is 87%.