Question

Harold Reese must choose between two bonds:
  
Bond X pays $76 annual interest and has a market value of $840. It has 10 years to maturity.
Bond Z pays $86 annual interest and has a market value of $800. It has three years to maturity.
Assume the par value of the bonds is $1,000.
  
a. Compute the current yield on both bonds. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)
  

  
b. Which bond should he select based on your answers to part a?

	Bond Z
	Bond X

c. A drawback of current yield is that it does not consider the total life of the bond. For example, the approximate yield to maturity on Bond X is 10.18 percent. What is the approximate yield to maturity on Bond Z? The exact yield to maturity? (Use the approximation formula to compute the approximate yield to maturity and use the calculator method to compute the exact yield to maturity. Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)

   
    
d. Has your answer changed between parts b and c of this question?

	No
	Yes

Answer 1

Solution:

Bond X : Face value = 1000, current value= $840, Coupon = 76 and Maturity = 10 years

Bond Z : Face value = 1000, current value= $800, Coupon = 86 and Maturity = 3 years

Part A )

Current yield = Coupon / Current price

Current yield of bond X = 76 / 840 = 9.05%

Current yield of Bond Z = 86 / 800 = 10.75%

Part B )

We will select bond Z as it has a higher current yield

Part C )

Approximate yield formula

YTM for bond Z = (86 + (1000-800)/3) / (( 1000+800)/2) = (86+66.67) / 900 = 16.96%

Exact yield to maturity : Answer = 16.59%

Part D )

The answer will remain the same. The yield is high in case of bond Z.