GARP Book 4 -Question 11.12

[liyi1989]

Question 11.11: A bond paying a coupon at the rate of 6% is held for six months. The price at the beginning of the six months is 102 and the price at the end of the six months is 101. What is the gross return?

Question 11.12: If the bond in Question 11.11 is financed at 2% (per annum), what is the net return?

Answer:





In 11.11, the bond is held for six months.
So in 11.12, I assume the finance cost is half-a-year interest (0.02/2) * 102 (instead of the one in the solution for the full year 0.02*102)? or did I miss anything? Thanks!

 

[David Harper CFA FRM]

HI @liyi1989 Yep, definitely a mistake. Nice catch! The question is correct to specify the borrowing (financing) rate in per annum terms per
"If the bond in Question 11.11 is financed at 2% (per annum), what is the net return?" as such consistency avoids confusion when reading inputs, but then the actual interest charge is (0.02/2) * 102, just as you say. So for the answer to 11.12, I get (101 + 3 - 103.02)/102.00 = 0.961% where 103.02 is the loan repayment equal to $102.00*(1 + 2.0%/2) = 103.020. Further, it's my opinion that a well-specified question will remind the reader that the answer is a holding period return (HPR), in this case 11.12 is looking for a realized net holding period return. (The previously assigned Tuckman is specific about this!) Why does this matter? Because otherwise some candidates might understandably annualize the 0.961 into a (valid) annualized net realized return (of 1.922%). Thank you,