Problem 16-2 Bond yields [LO2] Preston Corporation has a bond outstanding with a

Question

Problem 16-2 Bond yields [LO2] Preston Corporation has a bond outstanding with an annual interest payment of $80, a maturity date in 10 years. Assume the par value of the bond is $1,000 Find the following: (Use the approximation formula to compute theapproximate yield to maturity and use thecalculator method to compute the exact yield to maturity. Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.) All input values are shown in yellow. Only these values need changed to review algo versions. Answers are displayed in red. Connect tolerances are listed below the solution. Assumptions and other problem notes are displayed at the very bottom. Input variables: Annual interest Market price Maturity date Par value $80 $1,250 10 years $1,000 Solution and Explanation: a. Annual interest/Par Value Coupon rate b. Annual interest/Market Price Current yield

Explanation / Answer

Answer a.

Coupon Rate = Annual Interest / Par Value
Coupon Rate = $80 / $1,000
Coupon Rate = 8.00%

Answer b.

Current Yield = Annual Interest / Market Price
Current Yield = $80 / $1,250
Current Yield = 6.40%

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 = [$80 + ($1,000 - $1,250) / 10] / [0.60 * $1,250 + 0.40 * $1,000]
Approximate Yield to Maturity = $55 / $1,150
Approximate Yield to Maturity = 4.78%

So, approximate yield to maturity is 4.80%

Answer c-2.

Using financial calculator:

N = 10
PV = -1250
PMT = 80
FV = 1000

I = 4.80%

So, exact yield to maturity is 4.80%

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