Question

Matt Barnes has a choice of two 5-year bonds and is seeking the highest return. Given the following information about each bond, which one should he choose?

Bond A's coupon is 7.40% and is priced at 98.90 per 100

Bond B's coupon is 7.05% and is priced at 97.17 per 100

Answer 1

Given about two 5 year bond,

Bond A,

Let Face value = $100

Coupon rate = 7.4%

=> annual coupon payment = 7.4% of 100 = $7.4

Price = $98.90

So, yield on this bond is calculated on financial calculator using following values:

FV = 100

PV = -98.9

PMT = 7.4

N = 5

compute for I/Y, we get I/Y = 7.67%

So, yield on bond A is 7.67%

Bond B,

Let Face value = $100

Coupon rate = 7.05%

=> annual coupon payment = 7.05% of 100 = $7.05

Price = $97.17

So, yield on this bond is calculated on financial calculator using following values:

FV = 100

PV = -97.17

PMT = 7.05

N = 5

compute for I/Y, we get I/Y = 7.75%

So, yield on bond B is 7.75%

Since yield on bond B is higher, it should be selected.