Question

CURRENT YIELD, CAPITAL GAINS YIELD, AND YIELD TO MATURITY

Pelzer Printing Inc. has bonds outstanding with 9 years left to maturity. The bonds have a 9% annual coupon rate and were issued 1 year ago at their par value of $1,000. However, due to changes in interest rates, the bond's market price has fallen to $905.35. The capital gains yield last year was -9.465%.

A.What is the yield to maturity? Do not round intermediate calculations. Round your answer to two decimal places. %________

B. For the coming year, what is the expected current yield? (Hint: Refer to footnote 7 for the definition of the current yield and to Table 7.1.) Do not round intermediate calculations. Round your answer to two decimal places. %_________

For the coming year, what is the expected capital gains yield? (Hint: Refer to footnote 7 for the definition of the current yield and to Table 7.1.) Do not round intermediate calculations. Round your answer to two decimal places. %__________

Will the actual realized yields be equal to the expected yields if interest rates change? If not, how will they differ?

A. As long as promised coupon payments are made, the current yield will change as a result of changing interest rates. However, changing rates will not cause the price to change and as a result, the realized return to investors should equal the YTM.

B. As rates change they will cause the end-of-year price to change and thus the realized capital gains yield to change. As a result, the realized return to investors will differ from the YTM.

C. As long as promised coupon payments are made, the current yield will change as a result of changing interest rates. However, changing rates will cause the price to change and as a result, the realized return to investors will differ from the YTM.

D. As long as promised coupon payments are made, the current yield will not change as a result of changing interest rates. However, changing rates will cause the price to change and as a result, the realized return to investors should equal the YTM.

E. As long as promised coupon payments are made, the current yield will change as a result of changing interest rates. However, changing rates will cause the price to change and as a result, the realized return to investors should equal the YTM.

Answer 1

a)
Calculation of yield to maturity:

FV = 1000
PV = 905.35
PMT = 1000 * 9% = 90
Nper = 9

Yield to maturity can be calculated by using the following excel formula:
=RATE(nper,pmt,pv,fv)
=RATE(9,90,-905.35,1000)
= 10.69%

Yield to maturity = 10.69%

b)
Current yield = Annual coupon payment / Current price
= $90 / $905.35
= 9.94%

Current yield = 9.94%

Capital gain = Yield to maturity - current yield
= 10.69% - 9.94%
= 0.75%

Capital gain = 0.75%

As rates change they will cause the end-of-year price to change and thus the realized capital gains yield to change. As a result, the realized return to investors will differ from the YTM.