D Patriots Email Attempts: 4 6. Bond yields and prices over time A bond investor

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D Patriots Email Attempts: 4 6. Bond yields and prices over time A bond investor is analyzing the following annual coupon bonds: Study! Guide RedShelf D The University of Tex, H Yuzur Library 11P Do No Harm: 5.3/8 Issuing Company Smith Enterprises Irwin Incorporated Johnson Metalworks Annual Coupon Rate 696 12% 9% Each bond has 10 years until maturity and has the same risk. Their yield to maturity (YTM) is 9%. Interest rates are assumed to remain constant over the next 10 years. Label the curves on the following graph to indicate the path that each bond's price, or value, is expected to follow BOND VALUE IS 200 1100 1000 YEARS TO MATURITY Based on the preceding information, which of the following statements are true? Check all that apply The expected capital gains yield for Smith's bonds is positive. Johnson's bonds are a better investment than irwin's bonds. D All of the bonds will have the same value when they reach maturity. trwin's bonds are a better investment than Smith's bonds Smith just registered and issued its bonds, which will be soid in the bond market for the first time. Smith's bends would be referred to as

Explanation / Answer

a) Smith Irwin Johnson Face Value $1,000.00 $1,000.00 $1,000.00 Coupon Rate 6.00% 12.00% 9.00% Period 10 10 10 Coupon Payment $60.00 $120.00 $90.00 Yield = Rate 9.00% 9.00% 9.00% Present Value $807.47 $1,192.53 $1,000.00 Smith's’s coupon rate (6%) is less than its YTM (9%), so it sells at a discount. A discount bond’s current price is below the par value ($1,000) and rises over time until maturity. Therefore, the bottom curve on the graph represents Simth's price over time. Irwin ’s coupon rate (12%) exceeds its YTM (9%), so it sells at a premium. A premium bond's current price is above the par value ($1,000) and falls over time until maturity. Therefore, the top curve on the graph represents Irwin’s price over time. Johnson's coupon rate (9%) equals its YTM (9%), so it sells at par. A par value bond's current price equals the par value ($1,000), and it is expected to stay constant over time until maturity. Therefore, the middle curve on the graph represents Johnson’s price over time. b) All of the bonds will have the same value when they reach maturity Bonds will all be exactly worth their par value of $1,000 The Expected Capital gain Yield for Smith's bond is positive CGY = ($1000 - $807.47)/$807.47 23.84% All of the bonds have a YTM of 9%, so they are all equally good investments c) Smith just registered and issued its bonds, which will be sold in the bond market for the first time. Smith’s bonds would be referred to as a new issue

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