A 20-year bond with a face value of P5,000 is offered for sale at P3,800. The...

A 20-year bond with a face value of P5,000 is offered for sale at P3,800. The rate of
interest on the bond is 7%, paid semiannually. This bond is now 10 years old (the owner
has received 20 semiannual interest payments). If the bond is purchased for P3, 800,
what effective rate of interest would be realized on this investment opportunity?

Expert Solution

Here face value = 5000 P

Current market price = 3800 P

Interest = Face value x coupon rate x 1/2

= 5000 x 7% x 1/2

= 175 P

n = no of coupon payments = 20

YTM = Interest +(Face value -current market price/n) / (Face value + current market price/2)

= 175 + (5000-3800 / 20) / (5000+3800 / 2)

= 175 + (1200/20) / 8800/2

= 175 + 60 / 4400

= 235 /4400

= 0.0534

i.e 5.34%

Thus annual YTM = 5.34 x 2 = 10.68%

Effective rate of interest that would be realized on this investment opportunity = 10.68%

jeff jeffy answered 2 years ago

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