Question

Harold Reese must choose between two bonds: Bond X pays $85 annual interest and has a market value of $780. It has 12 years to maturity. Bond Z pays $95 annual interest and has a market value of $800. It has five years to maturity. Assume the par value of the bonds is $1,000.

A. Compute the current yield on both bonds

Bond X 0.1089 or 10.89

Bond Z 0.1062 or 10.62

C. A drawback of current yield is that it does not consider the total life of the bond. For example, the approximate yield to maturity on Bond X is 11.90 percent. What is the approximate yield to maturity on Bond Z? The exact yield to maturity?

Approximate yield to maturity 16.19 (??????)

(How do you get the Exact yield to maturity) for this problem?

Answer 1

a). Current Yield = Annual Coupon Payment / Current Bond Price

Current Yield(Bond X) = $85 / $780 = 0.1090, or 10.90%

Current Yield(Bond Z) = $95 / $800 = 0.1188, or 11.88%

c). Approximate YTM = [C + {(F - P) / n}] / [(F + P) / 2]

Approximate YTM(Bond X) = [$85 + {($1,000 - $780) / 12}] / [($1,000 + $780) / 2]

= [$103.33 / $890] = 0.1161, or 11.61%

Approximate YTM(Bond Z) = [$95 + {($1,000 - $800) / 5}] / [($1,000 + $800) / 2]

= [$135 / $900] = 0.15, or 15%

To find the exact YTM, we need to put the following values in the financial calculator;

For Bond X:

INPUT	12		-780	85	1,000
TVM	N	I/Y	PV	PMT	FV
OUTPUT		12.06

Hence, YTM = 12.06%

For Bond Z:

INPUT	5		-800	95	1,000
TVM	N	I/Y	PV	PMT	FV
OUTPUT		15.54

Hence, YTM = 15.54%