Question

The 18​-year, ​$1,000 par value bonds of Waco Industries pay 6 percent interest annually. The market price of the bond is ​$875​, and the​ market's required yield to maturity on a​ comparable-risk bond is 9 percent.

a.  Compute the​ bond's yield to maturity. (Round to two decimal​ places.)

b.  Determine the value of the bond to you given the​ market's required yield to maturity on a​ comparable-risk bond. (Round to two decimal​ places.)

c.  Should you purchase the​ bond?

Answer 1

Answer to Part a.

Face Value = $1,000
Current Price = $875

Annual Coupon Rate = 6%
Annual Coupon = 6% * $1,000
Annual Coupon = $60

Time to Maturity = 18 years

Let Annual YTM be i%

$875 = $60 * PVIFA(i%, 18) + $1,000 * PVIF(i%, 18)

Using financial calculator:
N = 18
PV = -875
PMT = 60
FV = 1000

I = 7.27%

Annual YTM = 7.27%

Answer to Part b.

Annual YTM = 9.00%

Value of Bond = $60 * PVIFA(9.00%, 18) + $1,000 * PVIF(9.00%, 18)
Value of Bond = $60 * (1 - (1/1.09)^18) / 0.09 + $1,000 * (1/1.09)^18
Value of Bond = $60 * 8.755625 + $1,000 * 0.211994
Value of Bond = $737.33

Answer to Part c.

You should not purchase this bond as its market price is higher than value of bond.