Question

The Lucky Co. bonds have 6 years remaining to maturity. Interest is paid annually; the bonds have a $1,000 par value; and the coupon interest rate is 5 percent.

a. What is the yield to maturity at a current market bond price of (1) $900 or (2) $1,100? If you could not get the final answer, take a guess on whether the yield to maturity is greater or less than 10 percent. (Remember for every price, there is a ytm, so we are looking for two ytms corresponding to these two bond prices.)

b. Would you pay $1100 for one of these bonds if you thought that the appropriate rate of interest was 10 percent? Explain your thought process.

Answer 1

a: Using financial calculator
Input: FV= 1000

N = 6

PMT = 5%*1000 = 50

PV = -900

Solve for I/Y as 7.1%

YTM = 7.1%

2:

Using financial calculator
Input: FV= 1000

N = 6

PMT = 5%*1000 = 50

PV = -1100

Solve for I/Y as 3.15%

YTM = 3.15%

b: Price at YTM = 10% is

Using financial calculator
Input: FV= 1000

N = 6

PMT = 5%*1000 = 50

I/Y = 10

Solve for PV as -782.24

Hence the price should be $782.24 and so the bond should not be purchased for $1100 as it will be overpriced.