Question

Hooper Printing Inc. has bonds outstanding with 9 years left to maturity. The bonds have an 9% annual coupon rate and were issued 1 year ago at their par value of $1,000. However, due to changes in interest rates, the bond's market price has fallen to $905.35. The capital gains yield last year was - 9.465%.

1. What is the yield to maturity? Round your answer to two decimal places.
2. For the coming year, what is the expected current yield?
3. For the coming year, what is the expected capital gains yield?
4. Will the actual realized yields be equal to the expected yields if interest rates change? If not, how will they differ? (This question is MC)

I. As rates change they will cause the end-of-year price to change and thus the realized capital gains yield to change. As a result, the realized return to investors will differ from the YTM.

II. As long as promised coupon payments are made, the current yield will change as a result of changing interest rates. However, changing rates will cause the price to change and as a result, the realized return to investors will differ from the YTM.

III. As long as promised coupon payments are made, the current yield will not change as a result of changing interest rates. However, changing rates will cause the price to change and as a result, the realized return to investors should equal the YTM.

IV. As long as promised coupon payments are made, the current yield will change as a result of changing interest rates. However, changing rates will cause the price to change and as a result, the realized return to investors should equal the YTM.

V. As long as promised coupon payments are made, the current yield will change as a result of changing interest rates. However, changing rates will not cause the price to change and as a result, the realized return to investors should equal the YTM.

Answer 1

a)
FV = 1000
PMT = 1000 * 9% = 90
Nper = 9
PV = 905.35

Yield to maturity can be calculated by using the following excel formula:
=RATE(nper,pmt,pv,fv)
=RATE(9,90,-905.35,1000)
= 10.69%

Yield to maturity = 10.69%

b)
Current yield = Coupon payment / bond price
= 90 / 905.35
= 9.94%

c)
Capital gain yield = YTM - current yield
= 10.69% - 9.94%
= 0.75%

d)
No.
As rates change they will cause the end-of-year price to change and thus the realized capital gains yield to change. As a result, the realized return to investors will differ from the YTM.