Question

Suppose a corporate bond that reaches maturity on 07/01/2036 is trading today (9/29/2020) for $763. The bond certificate indicates that the stated coupon rate for this bond is 5% and that the coupon payments are to be made semiannually.

a. Compute YTM of the bond. Clearly state your Excel / Calculator inputs. Suppose the bond’s credit rating is BB.

b. Would you use YTM as a reasonable estimate of the investment rate of return on the bond? Explain your answer.

c. If your answer to b) is “no”, give two alternative estimates of the investment return on the bond. Assume that the risk free-rate is 2.5% and market expected rate of return is 8%. (in your estimates use recession values)

Answer 1

Formula Used:-

Yield to Maturity=YIELD(B40,B39,B42,B41,1000,2)*2

B. No, major disadvantage of YTM is that it does not consider the risk of Investment that is the major factor that affect the required rate of return, if the bond is more risky then Investors must get higher return. That means the return on any Investment must consider the risk involved in that security.

C.

As Bond is BB rated let's assume it's beta = 1.25

Expected return = Rf + beta*(Rm+Rf)

=2.5% + 1.25*(8%-2.5%)

= 2.5%+ 6.875%

= 9.375%