Question

Consider a 7% coupon bond selling for 953.10 with 3 years to maturity , making annual payment. The interest rate will be 10% and 12%. Calculate yield to maturity and realized compound yeild of the bond

Answer 1

Consider FV= 1000

PMT = 70

N=3

PV = -953.10

Put all these values in the financial calculator you will get the value of YTM as 8.847%

Now the reinvestment rate is not the same as the YTM so the realized yield will be different than the YTM

If the coupons are reinvested at 10% rate of interest the realized yield will be

Total FV =1100+100(1.10)+100(1.10)^2 = 1331

Now put FV = 1331

and PMT = 0

CPT I/Y = 11.76%

If the coupons are reinvested at 12% rate of interest the realized yield will be

Similarly FV = 1436.2

PV=0

PMT =70

N=3

I/Y=12%

..................

Now realised yield =

14.6%

Putting PV=-953.10

FV= 1436.2

N=3

PMT=0

We get I/Y = 14.6%