Question

An investor must choose between two bonds:

Bond A pays $102 annual interest and has a market value of $890. It has 10 years to maturity.

Bond B pays $88 annual interest and has a market value of $800. 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 she select based on your answers to part a?
  

	Bond A
	Bond B

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 A is 12.10 percent. What is the approximate yield to maturity on Bond B? The exact yield to maturity? (Use the approximation formula to compute the approximate yield to maturity and use the calculator method 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 in terms of which bond to select?
  

	Yes
	No

Answer 1

Part A:

Current Yield = Coupon Amount / Bond Price

Bond A = $ 102 / 890

= 0.1146 i.e 11.46%

Bond B = $ 88 / $ 800

= 0.11 i.e 11.00%

Part B:

Bond A has been selected as its current Yield is more

Part C:

YTM is the actual return that received from Bond.

Bond A YTM:

YTM = Rate at which least +ve NPV + [ NPV at that rate / change NPV due to inc of 1% in rate ] * 1%

= 12% + [ 8.32 / 50.26 ] * 1%

= 12% + 0.17% i.e 12.17%

Bond B YTM:

YTM = Rate at which least +ve NPV + [ NPV at that rate / change NPV due to inc of 1% in rate ] * 1%

= 12% + [ 19.19 / 47.10 ] * 1%

= 12% + 0.41% i.e 12.41%

YTM to Bond B is 12.41%

PartD:

Bond B can be selected as it having more YTM compared to Bond A

Thus answer is changed between Part B & Part C.