Question

Yield to maturity

A firm's bonds have a maturity of 8 years with a $1,000 face value, have an 8% semiannual coupon, are callable in 4 years at $1,050, and currently sell at a price of $1,096.35.

What is their nominal yield to maturity? Round your answer to two decimal places.

%

What is their nominal yield to call? Round your answer to two decimal places.

%

What return should investors expect to earn on these bonds?

Investors would expect the bonds to be called and to earn the YTC because the YTM is less than the YTC.

Investors would expect the bonds to be called and to earn the YTC because the YTC is greater than the YTM.

Investors would not expect the bonds to be called and to earn the YTM because the YTM is greater than the YTC.

Investors would not expect the bonds to be called and to earn the YTM because the YTM is less than the YTC.

Investors would expect the bonds to be called and to earn the YTC because the YTC is less than the YTM.

Answer 1

The yield to maturity formula is used to calculate the yield on a bond based on its current price on the market. The yield to maturity formula looks at the effective yield of a bond based on compounding as opposed to the simple yield which is found using the dividend yield formula.

Notice that the formula shown is used to calculate the approximate yield to maturity. To calculate the actual yield to maturity requires trial and error by putting rates into the present value of a bond formula until P, or Price, matches the actual price of the bond. Some financial calculators and computer programs can be used to calculate the yield to maturity.

The Yield to Maturity to this bond is 6.44%, if you buy this bond.

The formula to calculate the yield-to-call looks slightly complicated, but it is actually quite straightforward. The components of the formula are as follows:

P = the current market price

C = the annual coupon payment

CP = the call price

t = the number of years remaining until the call date

YTC = the yield to call

The complete formula to calculate yield to call is:

P = (C / 2) x {(1 - (1 + YTC / 2) ^ -2t) / (YTC / 2)} + (CP / (1 + YTC / 2) ^ 2t)

The YTC is 11.13%, If you buy this bond today, you will earn 11.13% per year if the bond is called on the call date.

Investors would expect the bonds to be called and to earn the YTC because the YTM is less than the YTC.