Question

(a) A bond has a coupon rate of 4.5%, a maturity date of 1 June 2019, a current value of £96.00 and coupon frequency is annual. If today is 1 June 2016, calculate the current yield, the yield to maturity and the duration of the bond.    

(b) Critically assess the important assumptions made when you calculate the yield to maturity.       

(c) Identify the three most important determinants of the price of a bond and describe the effect of each determinant.      

Answer 1

Answer for a)

Current yield can be calculated as =4.5/96=4.6875%

Current yield to maturity can be calculated as

96=4.5/(1+r)+4.5/(1+r)^2+104.5/(1+r)^3

Then r=6%

Duration of Bond

(4.5/(1.06)+9/1.06^2+13.5/1.06^3+300/1.06^3)/96=2.8695 years

We equalise market price with discounted future payoff of bond that interest rate ia called as YTM means yield to maturity

Answer for c

Price, Yield to Maturity and Duration of Bond  

Price increase will decrease the chances of more appreciation hence interest rate will decrease

Price and YTM have inverse relationship.Duration of bond says in how many years the amount invested will be recovered.

Higher the Duration of Bond risky the bond is and vice versa