Question

1. Two corporate bonds have 4 years left to maturity. Interest is paid annually. The bonds have a $1,000 par value, and a coupon rate of 8%.

a) What is the yield to maturity at a current market price of (1) $864 and (2) $1,077?

b) Would you pay $864 for each bond if you thought that “fair” market interest rate for such bonds was 11% ------that is, if r =11%? Explain your answer.

Answer 1

Bond par value = $1,000

Coupon Rate = 8% annually

Time to maturity = 4 years

a.

If Current price of bond = $864

Using TVM calculation,

YTM = [PV = 864, FV = 1000, T = 4, PMT = 80]

YTM = 12.52%

If Current price of bond = $1077

Using TVM calculation,

YTM = [PV = 1077, FV = 1000, T = 4, PMT = 80]

YTM = 5.78%

b.

If YTM = 11%

Using TVM calculation,

PV = [FV = 1000, T = 4, PMT = 80, YTM = 11]

PV = $906.93

For YTM = 11%, Fair value of Bond = $906.93, so one would surely pay $864 for this bond.