Bond A pays $72 annual interest and has a market value of $925. It has ten years
ID: 2719642 • Letter: B
Question
Bond A pays $72 annual interest and has a market value of $925. It has ten years to maturity.
Compute the current yield on both bonds. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)
A drawback of current yield is that it does not consider the total life of the bond. For example, the approximate yield to maturity on Bond A is 8.33 percent. What is the approximate yield to maturity on Bond B? The exact yield to maturity? (Use the approximation formula to compute the approximate yield to maturity and use the calculator method to compute the exact yield to maturity. Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)
Explanation / Answer
current yield=Annual interest/ market value of bond
Bond A=72/925=7.78% current yield
Bond B=62/910=6.81% current yield
a. Current yield: Bond A-->7.78% Bond B--> 6.81%
b. He should select Bond A. It has highest yield.
approximate YTM of B=<annual int pymt+(principalpymnt-price of bond)/no.of years of maturity>
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0.6(Price of Bond)+0.4(Principal payment)
YTM of B= <62+(1000-910)/2>/(0.6*910+0.4*1000)=107/946=11.31%
c. Approx YTM of B=11.31%
d.Yes, Bond B has higher YTM. This is because the discount will be recovered over only two years.Bond A is a ten year bond