Question

Bond P is a premium bond with a coupon rate of 8 percent. Bond D has a coupon rate of 3 percent and is currently selling at a discount. Both bonds make annual payments, have a YTM of 5 percent, and have seven years to maturity.

  

a.	What is the current yield for Bond P and Bond D? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
b.	If interest rates remain unchanged, what is the expected capital gains yield over the next year for Bond P and Bond D? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

a) We will first calculate the Present value of bond P and D,

We can calculate the Pv in excel,

Bond P
Future Value	1000
pmt	80
interest	5%
No of years	7
Present Value	1173.59	(=PV(5%,7,-80,1000,0))

Pv of bond P = $1,173.59

Bond D
Future Value	1000
pmt	30
interest	5%
No of years	7
Present Value	884.27	(=PV(5%,7,-30,1000,0))

PV of bond D = $884.27

Current yield = Coupon rate / Price

Current yield for Bond P = 80/1173,59 = 6.82%

Current yield for Bond D = 30/884.27 = 3.39%

b) Capital gains yield = YTM - current yield

YTM = 5%

Capital gains yield for Bond P = 5% - 6.82% = -1.82%

Capital gains yield for Bond D = 5% - 3.39% = 1.61%

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