Question

Harold Reese must choose between two bonds: Bond X pays $78 annual interest and has a market value of $850. It has 13 years to maturity. Bond Z pays $88 annual interest and has a market value of $810. It has five years to maturity. Assume the par value of the bonds is $1,000. a. Compute the current yield on both bonds. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.) b. Which bond should he select based on your answers to part a? Bond Z Bond X c. A drawback of current yield is that it does not consider the total life of the bond. For example, the approximate yield to maturity on Bond X is 9.84 percent. What is the approximate yield to maturity on Bond Z? The exact yield to maturity? (Use the approximation formula to compute the approximate yield to maturity and use a calculator or Excel to compute the exact yield to maturity. Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.) d. Has your answer changed between parts b and c of this question? No Yes

Answer 1

Answer:

A)

We know that

Current yield of a bond==>(Yearly interest / market price of the bond) * 100

Bond X==>(78 / 850) x 100 ==> 0.09176 x 100 ==> 9.1764 ==> 9.18%

Bond Z==>(88 / 810) x 100 ==> 0.1086 x 100 ==> 10.86%   

B)

As Bond Z is graterthan Bond X

Return on Investment of Bond Z is More.

Therefore, Bond Z should he select based on the answers to part A.

C)

Approximate Yield to maturity on Bond Z==> [ (C + ((F-P)/n)) ] / [ (F+P)/2 ]

==> [ 88+(1000-810)/5 ] / [ (1000+810)/2 ]

==> 126/905 ==> 0.1392

Approximate Yield to maturity Bond Z==> 13.92%

For Exact yield to maturity:

Given that n==>5 years

PMT==>88

Present Value==>810

Face Value==>1000

After calculating, we get the Exact yield to maturity==>14.39%

D)

NO, the answer does not changed between parts b and part c of this question.

Because, Bond Z is giving best returns as we can see that its approximate yield to maturity on Bond Z is 13.95% which is grater than 9.84% as mentioned in question c(the approximate yield to maturity on Bond X is 9.84 percent).

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