Bond P is a premium bond with a coupon rate of 9 percent. Bond D has a coupon ra
ID: 2733606 • Letter: B
Question
Bond P is a premium bond with a coupon rate of 9 percent. Bond D has a coupon rate of 4 percent and is currently selling at a discount. Both bonds make annual payments, have a YTM of 6 percent, and have four years to maturity.
What is the current yield for bond P and bond D? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
If interest rates remain unchanged, what is the expected capital gains yield over the next year for bond P and bond D? (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
Bond P is a premium bond with a coupon rate of 9 percent. Bond D has a coupon rate of 4 percent and is currently selling at a discount. Both bonds make annual payments, have a YTM of 6 percent, and have four years to maturity.
Explanation / Answer
Answer:
Answer:
To find the capital gains yield and the current yield, we need to find the price of the bond. The current price of Bond P and the price of Bond P in one year is:
P: P0= $90(PVIFA6%,4) + $1,000(PVIF6%,4) = $1,103.95
P1= $90(PVIFA6%,3) + $1,000(PVIF6%,3) = $1080.19
Current yield = $90 / $1,103.95= .0815 or 8.15%
The capital gains yield is:
Capital gains yield = (New price – Original price) / Original price
Capital gains yield = ( $1080.19 – $1,103.95) / $1,103.95 = –.0215 or –2.15%
The current price of Bond D and the price of Bond D in one year is:
D: P0= $40(PVIFA6%,4) + $1,000(PVIF6%,4) = $930.7
P1= $40(PVIFA6%,3) + $1,000(PVIF6%,3) = $946.54
Current yield = $40 / $930.7= .0429 or 4.29%
Capital gains yield = ($946.54 – 930.7) / $930.7 = +.0170 or +1.70%
All else held constant, premium bonds pay high current income while having price depreciation as maturity nears ;discount bonds do not pay high current income but have price appreciation as maturity nears. For either bond, thetotal return is still 6%, but this return is distributed differently between current income and capital gains.
Current yield Bond P 8.15% Bond D 4.29%