4. A) Explain the total return, the current yield, and the capital gains yield for a...

A) Explain the total return, the current yield, and the capital gains yield for a bond and how each is determined.

B) What is price risk for a bond? What is reinvestment risk for a bond? What bonds would have the most price risk? What bonds would have the least price risk?

How is default risk measured for a bond? What lets you know a bond is investment grade? What lets you know that a bond is speculative (junk)?

Solutions

Expert Solution

Q-4)

a) The total return is equal to the total income that is received from the investment in a fixed income security, current yield measures the income on the price of the bond whereas the capital gain shows the price gain from buying and selling the bond. The total return on a bond consist of coupon income, reinvestment income from coupon and capital gain or loss from the bond. The current yield on a bond is calculated as annual coupon being paid on the bond divided by current price of the bond. The capital gain yield is the difference between the price at which you purchase the bond and the price which you well the bond.

b) Price risk refers to the change in fall in the price of the bond because of the increase in interest rate and reinvestment risk refers to the risk that the in the event the interest rate falls in the market the cash inflow would increase and it would be reinvested at lower rates which would cause the investor fall in income. Long term bonds have higher price risk because interest rate can change and the price of the bond can vary significantly where as bonds which are of short-term maturity have higher reinvestment risk.

c) Default risk is the risk that the issuer of the bond will default on its obligation to pay back the debt. There are many ways in which the default risk is measured, the most prominent one is credit rating. Credit rating is a rating given by debt rating agencies to different companies based on different financial metrics. Lower the credit rating higher is the default probability and vice versa. Another measure is the spread on the bond in comparison to treasury bond. Treasury bonds are considered to be risk free, so higher the spread over the treasury bond higher is the probability of default. The Investment grade and speculative grade are based on credit rating. Any credit rating below BBB is said to be of speculative or junk grade where as BBB or higher are considered to be of investment grade. Although different rating agencies use different metrics to show the difference between speculative and investment grade bonds.

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

1. Over the next year, what is the current yield, capital gains yield, and total return...

1. Over the next year, what is the current yield, capital gains yield, and total return (or total yield) of a 5 year bond with a 4% YTM and a coupon rate of 5%? Assume the YTM over the next year remains the same. 2. Same question as above, except the YTM at the end of the year has risen to 4.5%. (

What are the total return, expected dividend yield, and capital gains yield for the first year?

ABC Company just paid a dividend (Do) of $1.10. Due to a new product being introduced to the market, ABC expects to achieve a supernormal annual growth rate of 15% for the next four years. After that, growth is expected to return to the long-run constant rate of 8%. Investors require a 12% return on this stock.Question 1 : What are the total return, expected dividend yield, and capital gains yield for the first year?Question 2 : What are the...

Based on current dividend yields and expected capital gains, the expected return on portfolios A and...

Based on current dividend yields and expected capital gains, the expected return on portfolios A and B are 11% and 14% respectively. The beta of A is 0.8 while that of B is 1.5. The rate of exchange fund bill is currently 6%, while the expected return of the Hang Seng Index is 12%. The standard deviation of portfolio A is 10%, while that of B is 31%, and that of the index is 20%. a. If you currently hold...

Based on current dividend yields and expected capital gains, the expected rates of return on portfolios...

Based on current dividend yields and expected capital gains, the expected rates of return on portfolios A and B are 11% and 14%, respectively. The beta of A is .8, while that of B is 1.5. The T-bill rate is currently 6%, while the expected rate of return of the S&P 500 index is 12%. The standard deviation of portfolio A is 10% annually, while that of B is 31%, and that of the index is 20%. a. If you...

The capital gains yield (yield from growth) plus the dividend yield (yield from income) on a...

The capital gains yield (yield from growth) plus the dividend yield (yield from income) on a security is called the: A. total return. B. geometric return C. average period return. D. current yield. E. variance of returns .

Bond Problem: Formulas: current yield = Dollar income Capital gains = Ending value – Beg. Value...

Bond Problem: Formulas: current yield = Dollar income Capital gains = Ending value – Beg. Value Beginning value Beginning value Bond yield = current yield + capital gains yield Suppose that one year ago Cisco Systems sold a 15-year bond issue that had a $1,000 par value and a 7 percent coupon rate. Interest is paid semiannually. a. If the bond sold at $1,000 initially, what was the market interest rate when it was sold? b. If the going rate...

Bob has capital losses of $4,000 that exceed his capital gains in the current year. Of...

Bob has capital losses of $4,000 that exceed his capital gains in the current year. Of this amount, $1,200 is a short-term capital loss and $2,800 is a long-term capital loss. What is the amount and character of the capital loss carryforward? a. It will be a $1,000 capital loss pro rated between short-term ($300) and long-term ($700) based on the total amount of the excess capital loss. b. It will be a $1,000 long-term capital loss because Bob must...

Question