Question

A bond matures in 20 years and pays an 8 percent annual coupon. The bond has a face value of $1000 and currently sells for $900. What is the bond's current yield and yield to maturity?

Answer 1

(a)-Current yield on the Bond

Current yield on the Bond = [Annual coupon amount / Price of the Bond] x 100

= [($1,000 x 8.00%) / $900] x 100

= [$80 / $900] x 100

= 8.89%

(b)-Yield to maturity (YTM) of the Bond

• The Yield to maturity of (YTM) of the Bond is the discount rate at which the Bond’s price equals to the present value of the coupon payments plus the present value of the Face Value/Par Value
• The Yield to maturity of (YTM) of the Bond is the estimated annual rate of return expected by the bondholders for the bond assuming that the they hold the Bonds until it’s maturity period/date.
• The Yield to maturity of (YTM) of the Bond is calculated using financial calculator as follows (Normally, the YTM is calculated either using EXCEL Functions or by using Financial Calculator)

Variables	Financial Calculator Keys	Figure
Par Value/Face Value of the Bond [$1,000]	FV	1,000
Coupon Amount [$1,000 x 8.00%]	PMT	80
Market Interest Rate or Yield to maturity on the Bond	1/Y	?
Maturity Period/Time to Maturity [20 Years]	N	20
Bond Price/Current Market Price of the Bond [-$900]	PV	-900

We need to set the above figures into the financial calculator to find out the Yield to Maturity of the Bond. After entering the above keys in the financial calculator, we get the annual yield to maturity on the bond (1/Y) = 9.10%

“Hence, the Yield to maturity of (YTM) of the Bond will be 9.10%”