Question

1. Use the following corporate bond quote information to answer the questions that follow. Since this is a corporate bond, assume the company makes semi-annual coupon payments and also assume the bond matures on today’s date (May. 28) in its maturity year and the par value is $1,000. The price is a dollar term.

Company   Coupon(%) Maturity Price($) Yield

XYZ Inc. 7.000 May 28, 2025 976.67

a. What is the bond’s yield to maturity?

b. If your required return is 9% APR, would you buy this bond today? Show work to prove why or why not.

Answer 1

a.

Yield of the bond = [Interest + (Redemption value-Initial price)/ periods to maturity]/(redemption price + initial price)/2

Interest per semi annual period= par value* coupon % * 1/2 =$ 1000*7% *1/2 =$35

Redemption value=$ 1000

Initial price= $ 976.67

Period to maturity=5 years = 5*2 semi annual periods = 10

Yield = [35+(1000-976.67)/10]/(1000+976.67)/2 = 37.333/988.335=0.03777=3.7774% per semi annual period.

annual yield= semi annual yield *2 =3.7774% *2=7.55%

b.

Required APR=9%, since realised yield is 7.55%, I will not buy this bond today,

At 9% APR, price of the bond today should be = Coupon amount * Present value annuity factor(9%, 10 periods) + Redemption price *Present value inflow factor(9%, 10 periods)

= $ 35 *6.47165 +1000*0.4224 =$ 647.02

Since, the actual price is much higher, desired yield of 9% will not be realized if bought today.