Question

A) A Norwegian “oil”-bond has a 12 % coupon rate, matures in 20 years and pays interest semi-annually. The face value is 1,000 NOK. What is the current price of this “oil”-bond if the market rate of return (e.g. the discount rate) is 8 %?

B) Is this bond selling at par, premium or discount?

C) What is the current yield?

D) Is the yield to maturity (YTM) for this bond higher or lower than the current yield?

Answer 1

(a) Bond Coupon = 12 % payable semi-annually, Face Value = 1000 NOK, Maturity = 20 years or (20 x 2) = 40 half-years

Interest Rate = Applicable Discount Rate = 8 % per annum or 4 % per half-year

Semi-Annual Coupon = 0.12 x 1000 x 0.5 = $ 60

Bond Price = 60 x (1/0.04) x [1-{1/(1.04)^(40)}] + 1000 / (1.04)^(40) = $ 1395.85

(b) As the bond's market price is greater than its face value, the bond sells at a premium

(c) Current Yield = Annual Bond Coupon / Bond Price = (60 x 2) / 1395.85 = 0.08597 or 8.597 %

(d) Yield to Maturity equals the applicable interest rate and clearly the same is lower than the bond's current yield.