Chapter 6, Problem 1CC

Summary Introduction

Cash flows:

Inflow and outflow movement of cash is known as Cash flows. There are two types of cash flows, namely cash inflow and cash outflow. The payments refer to cash outflows and receipts refer to cash inflows.

Bond: A bond is an instrument evidencing a debt which is issued for the purpose of raising money by borrowing. It is an agreement between the issuer and a holder where the issuer is required to pay to the holder the bond’s par value with the interest at a specified date in the future.

To determine:

The type of cash flows that an investor of the bond will receive.

Answer to Problem 1CC

The types of cash flows that an investor of the bond will receive are principal value and coupons.

Explanation of Solution

There are two types of cash flows that a bond buyer receives.

Principal or face value: The Principal amount is the total amount that the investor invests in a bond. It is the amount on which interest is calculated and is repaid at the time of maturity.

Coupons:

Coupons are the annual interest payments that are made to the bondholder till maturity. It is calculated on the face value and is always paid at a fixed rate which is decided at the time of issue of the bond to avoid any delay in payment in future.

Conclusion

Thus, the cash flows that a bond buyer receives are Principal value and coupons.