Question

Bond P is a premium bond with a coupon rate of 11 percent. Bond D is a discount bond with a coupon rate of 5 percent. Both bonds make annual payments, have a YTM of 8 percent, and have five years to maturity.

  

Requirement 1:

What is the current yield for bond P? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

  

Current yield

%

  

Requirement 2:

What is the current yield for bond D? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

  

Current yield

%

  

Requirement 3:

If interest rates remain unchanged, what is the expected capital gains yield (i.e., the percentage change in the value of the bond) over the next year for bond P? (Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Round your answer to 2 decimal places (e.g., 32.16).)

  

Capital gains yield

%

  

Requirement 4:

If interest rates remain unchanged, what is the expected capital gains yield (i.e., the percentage change in the value of the bond) over the next year for bond D? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

  

Capital gains yield

%

Answer 1

Current yield = Annual Coupon/Current Price of Bond

Now, in order to calculate the current yield, we need to calculate the current price of bonds. Assume both of these bonds have a face value of $100. So, their current prices can be calculated using the formula:

where P is price of bond with periodic coupon C, periodic YTM i, number of periods to maturity n and face value M.

So, for bond P,

P (for P) = 43.92 + 68.06 = $111.98

Current Yield (for P) = 11/111.98 = 9.82% -------> Answer to 1

So, for bond D,

P (for D) = 19.96 + 68.06 = $88.02

Current Yield for D = 5/88.02 = 5.68%-------> Answer to 2

Now, in order to calculate the Capital gains yield, we need to calculate the price of bond next year,

So, for bond P,

P (for P) = 36.43 + 73.50 = $109.94

Capital gains for Bond P = (109.94/111.98) - 1 = -1.8% ------> Answer to 3

So, for bond D,

P (for D) = 16.56 + 73.50 = $90.06

Capital gains for Bond D = (90.06/88.02) - 1 = 2.32%------> Answer to 4