Investments, tenth edition

A: Reinvestment Rate 5 10%

B: Reinvestment Rate 5 8%

Future

Value:

Time:

$1,100

$100

Cash Flow:

0

$1,100 

= $1,100

100 

× 1.10  =  $   110

$1,210

Future

Value:

Time:

$1,100

$100

Cash Flow:

0

$1,100 

= $1,100

100 

× 1.08  =  $   108

$1,208

2

1

2

1

 Figure 14.5 

Growth of invested funds  

 If the interest rate earned on the first coupon is less than 10%, the final value of the 

investment will be less than $1,210, and the realized compound return will be less than 

10%. To illustrate, suppose the interest rate at which the coupon can be invested is only 

8%. The following calculations are illustrated in  Figure 14.5 , panel B.   

Future value of first coupon payment with interest earnings 5 $100 3 1.08 5   $   108

1

 Cash payment in second year (final coupon plus par value) 

$1,100

5

 Total value of investment with reinvested coupons 

$1,208

 The realized compound return is the compound rate of growth of invested funds, assum-

ing that all coupon payments are reinvested. The investor purchased the bond for par at 

$1,000, and this investment grew to $1,208.   

V

0

(1 1 r)

2

 5 V

2

$1,000(1 1 r)

2

 5 $1,208

r 5 .0991 5 9.91%