Question

Bond P is a 12 percent coupon bond that is selling at a premium. Bond D is a 6 percent coupon bond currently selling at a discount. Both bonds make semi-annual payments, have a YTM of 9 percent and have 5 years to maturity.

a. What is the current yield for bond P?

b. What is the current yield for bond D?

c. Assume the YYM decreases to 8%. Which bond is more sensitive to changes in the market interest rate making the bond riskier? Show your work!

(fully solved, no excel or calculator shortcuts)

Answer 1

Part A) Current yield for bond P

Periods	Event	Cash Flow	PVAF(4.5%,10)	Present Value
1-10	Coupon	6	7.9127	47.48
10	Redemption	100	0.6439	64.39
				111.87

Current Yeild =( Coupon / Present value )*100

= ( 12 / 111.87 ) *100

= 10.73%

Part A) Current yield for bond P

Periods	Event	Cash Flow	PVAF(4.5%,10)	Present Value
1-10	Coupon	3	7.9127	23.74
10	Redemption	100	0.6439	64.39
				88.13

Current Yeild =( Coupon / Present value )*100

= ( 6 / 88.13 ) *100

= 6.81 %

Part C)

Bond D is more riskier.

Explanation

Generally, bonds with long maturities and low coupons have the longest durations. These bonds are more sensitive to a change in market interest rates and thus are more volatile in a changing rate environment. Conversely, bonds with shorter maturity dates or higher coupons will have shorter durations.

In this case Bond D has low coupon, therefore its duration also less compared to Bond P, thereby it is more sensitive to a change in market interest rates and make bond riskier.