You Have 5 Years Until You Need to Take Your

question 28

Essay

You have 5 years until you need to take your money out of your investments to make a planned expenditure. Right now bonds are promising an 8% return. You buy a 5-year duration bond. After you buy the bond, interest rates fall to 6% and stay there for the full five years. You reinvest the coupons and earn 6%. Will your realized return be more or less than the originally promised 8%? Explain.

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Definitions:

Initial Investment

The initial outlay of money required to start a project, purchase an asset, or invest in a business venture.

Useful Life

The estimated period over which an asset is expected to be usable for the purpose it was acquired.

Salvage Value

The anticipated remaining value of an asset at the conclusion of its operational life.

Payback Period

The length of time required to recover the initial investment in a project, without accounting for the time value of money.