Question

RBS Bank has just announced its latest bond release: The RBS QUICK-BUCK BOND, maturing in 3 years, YTM of 6%, selling price $1,053.46 a. What is the coupon rate of the bond? b. What is the current yield of the bond? c. What happens to the coupon rate of the bond when interest rates range to 8%? d. What is your return if you intend to sell the bond after one year for $1,200?

Answer 1

Bond is a fixed income instrument which is issued by government, corporate bodies and bank etc. to pool the money as loan from its buyer, the investor. Bonds generally pays its buyer pre-defined periodic coupons amount (i.e coupon rate) till its maturity except zero coupon bond or deep discount bond.

Following information provided about RBS Quick Buck Bond -

Current Selling Price = $ 1,053.46

Maturity = 3 years

YTM (at beginning ) = 6%

a) Coupon rate of Bond

Bond's coupon payment i.e fixed periodic payment to bond holder are made at coupon rate.

Now, Yield to maturity (YTM) is a rate at which present value of all future cash flow bond equals to Price of Bond.

We have Current Price of Bond and YTM thus, we can calculate Coupon rate with following expression -

Thus, Coupon rate = 80/1000 = 0.08 = 8%

b) Current Yield of the bond

Thus, Current Yield = 7.594%

c) Impact on coupon rate when interest rate range to 8%

Coupon rate is the fixed rate for periodic payment, it doesn't change with change in interest rate. Thus, coupon rate remain same when interest rate range to 8%. However, an increase in interest rate reduce the price of the bond.

Please note - IF YTM is 8% and Bond Price $ 1053.46 at the beginning then, we can recalculate the Coupon rate as we calculated in point-a.

d) Return of bond at the end one year, when sale price of bond is $ 1,200

Where,

BV0 = Bond value at the beginning

BV1 = Bond value at year end

Thus, Return on Bond = 21.50%

Hope this will help, if you need any further explanation please comment.