Question

The 8-year $1,000 par bonds of Smith Inc. pay 14 percent interest. The market's required yield to maturity on a comparable-risk bond is 17 percent. The current market price for the bond is $940. What is your yield to maturity on the Smith bonds given the current market price of the bonds? _% Please round to two decimal places. What should be the value of the Smith bonds given the yield to maturity on a comparable risk bond? $_ Please round to the nearest cent. You should or should not purchase the Smith bonds at the current market price because they are currently over or under priced? Please select one of each.

Answer 1

Par Value = $ 1,000

Coupon interest = 14%

Coupon Payment = 140

Tenure = 8 years

YTM = 17%

Current market price = $ 940

YTM ( as required by question ) = [ Interest + ( maturity value - Actual price) / n ] / [ Maturity Value + issue value] / 2

= [ 140 + (1000-940)/8 ] / (1000+940) / 2

= 15.21%

Value of bond with thw given YTM = Coupon payment * PVAF ( 17%, 8 years) + Maturity Value * PVF ( 17%, 8 th year)

= 140 * (4.21) + 1000 * ( 0.285) = 874.4

With the present YTM of 17% the fair value of bond is $ 874.4 and the current price is $ 940. Hence the fair value < Actual Value which means the bond is overvalued and should not be purchased.