Question

Please answer the following questions regarding yield to maturity and its constituents.

a. What is the yield to maturity?

b. How does a bond’s current yield differ from its total return? Could it exceed the total return?

c. How is the current yield different from coupon rate?

d. How would you compute a bond’s capital gains yield, if you were given its yield to maturity, coupon rate, and current yield?

e. If interest rates in the economy rise after a bond has been issued, what will happen to the bond’s price and to its YTM? Explain.

Answer 1

Q A: What is the yield to maturity?

The yield to maturity is the percentage return for a bond assuming that the investor holds an asset till its maturity date. It is the sum of all its remaining coupon payments.Yield to maturiry is also known as redemption yield.

QB: How does a bond’s current yield differ from its total return? Could it exceed the total return?

Ans:Current yield is bond's annual return based on its annual coupon payments and current price.Total return is the growth of investor's portfolio value over period of time. In other word total return is return from interest ,capital gain,dividend, and distribution realised over period of time.

QC: How is the current yield different from coupon rate?

Ans:The bond's coupon rate is rate of interest it pays annually where as current yield is the rate of return the bond generate from its current performance.

QD: How would you compute a bond’s capital gains yield, if you were given its yield to maturity, coupon rate, and current yield?

Ans: Coupon rate is annual payout as apercentage of bond's par value. current yield is annual payout as percentage of market price you actually pays,yield to maturity is composite rate of return of all payouts i.e from coupon and capital gain.

- Bond's capital gain or loss can be calculated as difference between par value and current price you actually pays.

- equation for this is as follows:

c(1+r)-1 +c(1+r)-2 +c(1+r)-3 +.....+B(1+r)-Y =P

Where c=annual coupon payment

Y= no of years to maturity

B= par value of bond

p= purchase price.

Q5: If interest rates in the economy rise after a bond has been issued, what will happen to the bond’s price and to its YTM? Explain.

Ans: If inerest rate in the economy rises , bond price falls .and viceversa. when interest rate about to decrease investor make purchase of zero coupon bond and price of bond goes high. it explain the inverse relationship between bond price and interest rate of it.