Question

On October 15, 2016, Koala, Inc. issued a 10 year bond (with a typical $1000 face value) that had an annual coupon value of $60. [We are assuming that the 2020 coupon has just been redeemed.]

•   Initially, the bond was sold for the premium price of $1,025.
•   On October 15, 2020, this bond was selling for only $975.
•   The market rate of interest for a riskless corporate bond, of this maturity, was 4.5% on October 15, 2016, which reflects market expectations about future rates of inflation.
•   The market rate of interest for a riskless corporate bond, of this maturity, was 4.0% on October 15, 2020, which reflects market expectations about future rates of inflation.

1. What was the nominal yield on this bond on October 15, 2016? [To 1 decimal place.]

2. What was the current yield on this bond on October 15, 2016? [To 2 decimal places.]

Answer 1

1.   Face value = 1000 $

Annual coupon payment = 60 $

Nominal Yield = Annual coupon payment / Bond Face value * 100

(Nominal Yield is always calculated on Face value of the bond, is dosent change irrespective of bond price)

= 60 / 1000 * 100

= 6 %

2. copon payment = 60 $

Bond price on 15 october 2016 = with 4.5% interest rate the present value of bond will increase 1118.69 $ based on Excel calculation due to fall in interest rate

Current Yield on October 15, 2016 = Coupon Payment / Current Market Bond Price * 100

= 60 / 1118.69 * 100

= 5.36 %