. A 15-year bond ($1,000 par value) with semi-annual coupons is selling for $1,2
ID: 2739464 • Letter: #
Question
. A 15-year bond ($1,000 par value) with semi-annual coupons is selling for $1,200, and the coupon rate is 7.5%. The bond can be called in 5 years for a call price of $1,065. What are the current yield, yield to maturity and yield to call for this bond? If you were to buy this bond today, discuss which of the above three yields you think would best measure the actual rate of return for this investment, given that you plan to own it until it matures. Explain. Also, what would be the capital gains yield on this bond in the first year of ownership if interest rates remain the same for the first year of ownership?
Explanation / Answer
Compute Current yield.
Coupon amount = $1000*7.5% = $75/2 = 37.5.
Current yield = Coupon amount / current price of the bond.
= $37.5/$1200 = 0.03125 * 2 = 0.0625 or 6.25%.
Compute Yield to maturity:
Present value (PV) = 1200
Future value(FV) = 1000.
Nper = 15 * 2 = 30
Coupon amount (Pmt)= $75/2 = $37.5.
Compute the ytm using excel function.
YTM = Rate(Nper,Pmt,PV,FV) = Rate(30,37.5,-1200,1000) = 2.76 % * 2 = 0.05522 or 5.52%.
Compute yield to call for the bond.
Present value (PV) = 1200
Future value(FV) = 1065.
Nper = 5 * 2 = 10
Coupon amount (Pmt)= $75/2 = $37.5.
Compute the ytm using excel function.
YTM = Rate(Nper,Pmt,PV,FV) = Rate(10,37.5,-1200,1065) = 2.10 % * 2 = 0.0420 or 4.20%.
As the current yield of the bonds compares what the market return and the return on the bond. Here the coupon rate of the bond is more than the current yield thus the bond will be at premium we can know from it. It is the best measure to check before purchasing the bond and after that you need to compare it with YTM.
There is no capital gain yield on the bond as we are purchasing at premium and it is decreasing and thus there is no chance of capital gain.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.