Problem 16-1 Bond yields [LO2] The Pioneer Petroleum Corporation has a bond outs

Question

Problem 16-1 Bond yields [LO2] The Pioneer Petroleum Corporation has a bond outstanding with an $85 annual interest payment, a market price of $800, and a maturity date in five years. Assume the par value of the bond is $1,000. Find the following: (Use the approximation formula to compute the approximate yield to maturity. Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.) Input variables: Annual interest Market price Maturity date Par value $85 $800 5 years $1,000 Solution and Explanation: a. Annual interest/ Par Value Coupon rate b. Annual interest/Market Price Current yield Annual Principal payment interest+ Price of the bond pproximate payrent + yield to Number of years to maturity 1. maturity (Y') 0.6 (Price of the bond) + 0.4 (Principal payment) c-1 Approximate yield to maturity

Explanation / Answer

Answer a.

Coupon Rate = Annual Interest / Par Value
Coupon Rate = $85 / $1,000
Coupon Rate = 8.50%

Answer b.

Current Yield = Annual Interest / Market Price
Current Yield = $85 / $800
Current Yield = 10.63%

Answer c-1.

Approximate Yield to Maturity = [Annual Interest Rate + (Principal Payment - Price of Bond) / Number of years to Maturity] / [0.60 * Price of the bond + 0.40 * Principal payment]
Approximate Yield to Maturity = [$85 + ($1,000 - $800) / 5] / [0.60 * $800 + 0.40 * $1,000]
Approximate Yield to Maturity = $125 / $880
Approximate Yield to Maturity = 14.20%

So, approximate yield to maturity is 14.20%

Answer c-2.

Using financial calculator:

N = 5
PV = -800
PMT = 85
FV = 1000

I = 14.38%

So, exact yield to maturity is 14.38%

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