Question

Jamal owns two 10-year bonds that both have a yield to maturity of 4% that pay interest annually. One bond has a 4% coupon and trades at 100% (par). The other bond has a 2% coupon and trades at 83.78%.

a.   What is the current yield of the 4% bond?

b.   What is the current yield of the 2% bond?

Answer 1

- Current Yield = Annual Coupon Payment/Current Price

a). Annual Coupon Payment of 4% bond = Face Value*Coupon rate

=$1000*4%

= $40

Current Price of 4% is at par which is equal to $1000

Current Yield of 4% Bond = $40/$1000

= 4%

So, the current yield of the 4% bond is 4%

b). Annual Coupon Payment of 2% bond = Face Value*Coupon rate

=$1000*2%

= $20

Current Price of 2% is trading at 83.78%

Current Price = $1000*83.78%

= $837.8

Current Yield of 2% Bond = $20/$837.8

= 2.39%

So, the current yield of the 2% bond is 2.39%

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