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On October 15, 2016, Koala, Inc. issued a 10 year bond (with a typical $1000 face...

On October 15, 2016, Koala, Inc. issued a 10 year bond (with a typical $1000 face value) that had an annual coupon value of $60.  [We are assuming that the 2020 coupon has just been redeemed.]

  • Initially, the bond was sold for the premium price of $1,025.
  • On October 15, 2020, this bond was selling for only $975.
  • The market rate of interest for a riskless corporate bond, of this maturity, was 4.5% on October 15, 2016, which reflects market expectations about future rates of inflation.
  • The market rate of interest for a riskless corporate bond, of this maturity, was 4.0% on October 15, 2020, which reflects market expectations about future rates of inflation.

1.  What was the nominal yield on this bond on October 15, 2016?  [To 1 decimal place.]

2.  What was the current yield on this bond on October 15, 2016?  [To 2 decimal places.]

3.  What was the yield to maturity for this bond on October 15, 2016?  [To 3 decimal places.]

4.  What was the risk premium for this bond on October 15, 2016?  [To 3 decimal places.]

5.  What was the nominal yield on this bond on October 15, 2020?  [To 1 decimal place.]

6.  What was the current yield on this bond on October 15, 2020?  [To 2 decimal place.]

7.  What was the yield to maturity for this bond on October 15, 2020?  [To 3 decimal places.]

8.  What was the risk premium for this bond on October 15, 2020?  [To 3 decimal places.]

9.  It is now October 15, 2020 and suddenly the Federal Reserve announces a massive program to reduce inflation.  Instantly, the market rate of interest for a riskless corporate bond that would apply to this bond, falls from 4.0% to 2.5%.  If there is no change in the risk premium expected for this Koala, Inc. bond, what will be this bond’s yield to maturity?  [To 3 decimal places.]

Solutions

Expert Solution

Current Yield=annual int payment*/current market price

15/10/2016 current yield=60*3.956/1000=0.24

15/10/2020 current yield=60*3.631/975=0.23

Nominal Yield=annual int payment*/Face Value

15/10/2016 nominal yield=60*3.956/1000=0.24

15/10/2020 nominal yield=60*3.631/1000=0.22

Yield to maturity=(interest+(maturity value-Fair Market Price)/no.of years)/maturty value+fair market price/2

15/10/2016   =(0.06+(1025-1000)/4)/1025+1000/2=0.06+6.25/1012.5=6.31/1012.5=0.006

15/10/2020 =(0.06+(1025-975)/4)/1025+975/2=12.56/1000=0.013

Risk Premium =(Market value of bond-face value of bond)/face value of bond

15/10/2016= 1025-1000/1000=0.025

15/10/2020= 975-1000/1000= -0.025

YTM AFTER INTEREST CHANGE

Yield to maturity=(interest+(maturity value-Fair Market Price)/no.of years)/maturty value+fair market price/2

=(0.0025+(1025-975/4)/1025+975/2=12.525/1012.5= 0.0124

jeff jeffy answered 2 years ago
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