Question

• Five years ago Dynamic Systems issued a 15-year bond with a $1,000 par value and a 7 percent coupon rate. Interest is paid semiannually. Today the going interest rate is 10 percent, and it is ex- pected to remain at this level for many years in the future. Compute the (a) current yield and (b) capital gains yield that the bond will gener- ate in the fifth year (Year 5) of its life.

Answer 1

a.

Period	Cashflows	PV of cashflows
1	70	66.67
2	70	63.49
3	70	60.47
4	70	57.59
5	70	54.85
6	70	52.24
7	70	49.75
8	70	47.38
9	70	45.12
10	70	42.97
11	70	40.93
12	70	38.98
13	70	37.12
14	70	35.35
15	70	33.67
16	70	32.07
17	70	30.54
18	70	29.09
19	70	27.70
20	70	26.38
21	70	25.13
22	70	23.93
23	70	22.79
24	70	21.70
25	70	20.67
26	70	19.69
27	70	18.75
28	70	17.86
29	70	17.01
30	1070	247.57
	Bond Price	1,307.45

Current yield = 70 / 1307.45 = 0.0535 or 5.35%

b. Price of bond 5 years from now

Period	Cashflows	PV of cashflows
1	70	66.67
2	70	63.49
3	70	60.47
4	70	57.59
5	70	54.85
6	70	52.24
7	70	49.75
8	70	47.38
9	70	45.12
10	70	42.97
11	70	40.93
12	70	38.98
13	70	37.12
14	70	35.35
15	70	33.67
16	70	32.07
17	70	30.54
18	70	29.09
19	70	27.70
20	1070	403.27
	Bond Price	1,249.24

Coupons received = 70 * 10 =700

Capital gains = (1,249.24 + 700 - 1,307.45) / 1,307.45 = 49.08%

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