I'll be the first to admit that I know nothing about bonds. But the recent thread about GMAC bonds made me start poking around to learn more. I found some information on GM's bonds on their web site:
One interesting thing I noticed is that the bond pays $1.8125 per year in interest. At that rate, it would only take 3 years to earn back the current cost of the bond. In other words, as long as GM doesn't default on these bonds in the next 3 years, you'll at least get your principal back.
But assuming you hold on to the bond until maturity (and GM doesn't default on it), what kind of return will you get? It seems simple enough to calculate. The bond will pay $1.8125 per year for 32.5 years. That's a total of $58.90625 in interest. And when the bond matures, you get the par value back. That's another $25 for a grand total of $83.90625. That makes for an equivalent continuously compounded interest rate of ln(83.90625 / 5.54) / 32.5 = 8.36%.
Except... there's a major difference. In a traditional compounded interest scenario, you have to reinvest your interest. That's not the case here. In fact, the concept of reinvesting interest isn't even applicable unless you consider the case of buying new bonds. So maybe this bond has MORE than an 8.36% rate of return? Not sure how to think about that.
Anyway, that was my first foray in to thinking about bonds. Is all of this correct? BTW, I'm certainly not advocating buying GM bonds. This was just a thought exercise.
Thanks, Bill