Question

Harrimon Industries bonds have 5 years left to maturity. Interest is paid annually, and the bonds have a $1,000 par value and a coupon rate of 9%.

1. What is the yield to maturity at a current market price of
   1. $858? Round your answer to two decimal places.

          %

   2. $1,087? Round your answer to two decimal places.

          %

2. Would you pay $858 for each bond if you thought that a "fair" market interest rate for such bonds was 12%—that is, if r_d = 12%?
   1. You would not buy the bond as long as the yield to maturity at this price is greater than your required rate of return.
   2. You would not buy the bond as long as the yield to maturity at this price is less than the coupon rate on the bond.
   3. You would buy the bond as long as the yield to maturity at this price is greater than your required rate of return.
   4. You would buy the bond as long as the yield to maturity at this price is less than your required rate of return.
   5. You would buy the bond as long as the yield to maturity at this price equals your required rate of return.

Answer 1

a]

YTM is calculated using RATE function in Excel with these inputs :

nper = 5 (5years to maturity with 1 annual coupon payment each year)

pmt = 1000 * 9% (annual coupon payment = face value * annual coupon rate. This is a positive figure as it is an inflow to the bondholder)

pv = -858 (current bond price. This is a negative figure as it is an outflow to the buyer of the bond)

fv = 1000 (face value of the bond receivable on maturity. This is a positive figure as it is an inflow to the bondholder)

The RATE is calculated to be 13.04%. This is the YTM.

b]

YTM is calculated using RATE function in Excel with these inputs :

nper = 5 (5years to maturity with 1 annual coupon payment each year)

pmt = 1000 * 9% (annual coupon payment = face value * annual coupon rate. This is a positive figure as it is an inflow to the bondholder)

pv = -1087 (current bond price. This is a negative figure as it is an outflow to the buyer of the bond)

fv = 1000 (face value of the bond receivable on maturity. This is a positive figure as it is an inflow to the bondholder)

The RATE is calculated to be 6.88%. This is the YTM.

c]

III - You would buy the bond as long as the yield to maturity at this price is greater than your required rate of return. The YTM at this price is 13.04%. whereas your required rate of return is 12%.