Question

Yield to Maturity and Required Returns

The Brownstone Corporation's bonds have 6 years remaining to maturity. Interest is paid annually, the bonds have a $1,000 par value, and the coupon interest rate is 10%.

1. 1. What is the yield to maturity at a current market price of $835? Round your answer to two decimal places.

      ---------------%

   2. What is the yield to maturity at a current market price of $1,122? Round your answer to two decimal places.

      ---------------%

2. Would you pay $835 for one of these bonds if you thought that the appropriate rate of interest was 12% - that is, if r_d = 12%?

   -Select- ----------

   Explain your answer.

   I. You would buy the bond as long as the yield to maturity at this price equals your required rate of return.
   II. You would buy the bond as long as the yield to maturity at this price does not equal your required rate of return.
   III. You would buy the bond as long as the yield to maturity at this price is greater than your required rate of return.
   IV. You would buy the bond as long as the yield to maturity at this price is less than your required rate of return.

   -Select- -----------

Answer 1

Answer : (a.) Calculation of yield to maturity at current market price of $835:

Yield to maturity can be calculated using Rate Function of Excel :

Using Financial Calculator

=RATE(nper,pmt,pv,fv)

where nper is Number of years to maturity i.e 6

pmt is Interest payment i.e 1000 * 10% =100

pv is Current Market Price

= - 835

Note : pv should be taken as negative.

fv is face value i.e 1000 (Assumed)

=RATE(6,100,-835,1000)

therefore ,Yield to maturity is 14.28%

Calculation of yield to maturity at current market price of $1122:

Yield to maturity can be calculated using Rate Function of Excel :

Using Financial Calculator

=RATE(nper,pmt,pv,fv)

where nper is Number of years to maturity i.e 6

pmt is Interest payment i.e 1000 * 10% =100

pv is Current Market Price

= - 1122

Note : pv should be taken as negative.

fv is face value i.e 1000 (Assumed)

=RATE(6,100,-1122,1000)

therefore ,Yield to maturity is 7.41%

(b.) Correct Option is III. You would buy the bond as long as the yield to maturity at this price is greater than your required rate of return.

Reason :

At a price of 835 yield to maturity (as calculated above i.e 14.28%) is greater than the required return i.e 12% , therefore Buy the bond .