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3. Harry’s Diamond Emporium issued a bond with a 20-year maturity, a $1,000 par value, and...

3. Harry’s Diamond Emporium issued a bond with a 20-year maturity, a $1,000 par value, and a 10% coupon rate with semi-annual payments. Three years after the bond was issued, the going rate on similar risk bonds fell to 7 percent. It is expected to stay at this level for the remainder of the bond’s life.

a. Calculate the current yield and the capital gains yield that the bond will generate in the fourth year (Year 4) of its life. (Hint: Calculate the value of the bond after three years (17 years remaining) and four years (16 years remaining), then calculate the yields.)

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Answer #1

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a. Current Yield = Annual Coupon / Price after 3 years = 100 / $1189.77 = 8.40%

b. Capital gains Yield = YTM - Current Yield = 7% - 8.40% = - 1.40%

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