Lessons from the Lemonade Stand by James Berman

Author:James Berman
Language: eng
Format: epub
Tags: Lessons from the Lemonade Stand: A Common Sense Primer on Investing
ISBN: 9780615705200
Publisher: Jbglobal.Com L.L.C.
Published: 2012-12-03T16:00:00+00:00

Hapless George is in deeper than he thinks. Now that Ivan’s bond is identical except for the higher rate, the value of George’s bond has actually declined.

Assume a third lender named Dennis hears that Lucinda Lemonade Inc. is issuing bonds. He grows intrigued, wishing to receive the current juicy 7% interest yield. Meanwhile, George has decided that he actually would like his $50 back so that he can use the money to buy a lemon grove. George approaches Lucinda who sternly wags a finger at him and points to the language in the bond agreement that says George can only get his money back after the one year term of the bond has passed, after the bond has matured. Not easily discouraged, George intercepts Dennis on his way to Lucinda’s and offers him a deal: he will sell his 5% bond to Dennis in exchange for $50, effectively putting Dennis in his shoes. Dennis will now get his stream of interest, and George will have his $50 back.

Dennis, no dope, replies that Lucinda Lemonade Inc. is now issuing bonds that pay 7%. Why then, he asks, would he buy George’s 5% bond at all when he could get 7% by buying a new bond? Dennis suggests a solution: he will buy George’s $50 bond — not for $50 — but for $35. This way he will get the same interest stream that George would have gotten ($2.50) but on an investment of only $35, giving Dennis an effective yield of 7%:

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