Question

1. A bond issued by ABC Corp. has a face value of $1,000, coupon rate of 6%, price of $1,029.13 and time to maturity of one year. (PLEASE SHOW ALL WORK)

a. What is its current yield?

b. What is its yield to maturity?

c. Is this a discount, premium or par bond? Why?

d. Now suppose instead of having one year to maturity, it has two year to maturity and is priced $1,057.40. What is the current yield and the yield to maturity?

2. For each of the following bond features, state whether the feature will increase, decrease or have no effect on the price of the bond, all else being equal:

a. The bond is callable

b. The bond is convertible

c. The bond is puttable

d. 25-year bond has tax-exempt coupon payments

Answer 1

Part (1):

(a ): Current yield= 5.830167%

(b ): Yield to Maturity= 2.999621%

(c ): It is a premium bond because price is higher than face value. The reason for premium is the YTM lower than coupon rate.

(d): If the term is 2 years and price $1,057.40

(I ) Current yield= 5.674295%

(ii) YTM= 3.000205%

Details of calculation as follows:

Part (2):

(a ): Value of callable bond= Price of straight bond- price of call option. Hence the price is lower due to call option, all else being equal.

(b ): If the bond is convertible, price is higher, since the value of conversion option is added to the value of straight bond

(c ): Price of puttable bond is higher since the value of put option is added to the value of straight bond

(d ): Tax exemption on coupon payments enhances value of the bond and hence price will be higher, compared to others