WHY WOULD THE PRINCIPAL BE CALCULATED AS A SEMI ANNUAL RETURN WHEN - ProProfs Discuss

# Why would the principal be calculated as a semi-annual return when its just the coupon payments that are being paid semi-annually?

Asked by Daisy, Last updated: May 16, 2024

#### John Smith

John Smith

Assume you took your principal and bought a semi annual interest bearing security. since you could invest that money elsewhere and earn semi-annual compounding interest, it would be nice to know what the fair price for the principal is in terms of present value.for example, if the bond has a coupon rate of 10% and matures in 5 years and pays interest semi-annually, a fair price for the \$100 principal would be \$61.39. why doesthis make sense? because you could turn away from the issuer and turn toward a competitor that offers semi-annual compounding interest based on the same terms mentioned above:\$61.39 + 5% + 5% + 5% + 5% + 5% + 5% + 5% + 5% + 5% + 5% = \$100but what if you invested your principal in a bond that paid interest annually, had a coupon rate of 10% and matured in 5 years? a fair price would be \$62.09. why does thismake sense? because you could turn away from the issuer and turn toward a competitor that offers annual compounding interest based on the same terms:\$62.09 + 10% + 10% + 10% + 10% + 10% = \$100so if you turn back to the first scenario where \$61.39 is a fair price based on the terms of the investment, but you decide to offer \$62.09, the seller will gladly accept the extra money, knowing that you are paying more than you should for what the issuer is offering you.