Question

The 12-year, $1,000 par value bonds of Smith Industries pay 7 percent interest annually. The market price of the bond is $885, and the market’s required yield to maturity on a​ comparable-risk bond is 10 percent.

What is your yield to maturity on the Smith bonds given the current market price of the​ bonds? Round to two decimal places.

What should be the value of the Smith bonds given the​ market's required yield to maturity on a​comparable-risk bond? Round to the nearest cent.

You should or should not purchase the Smith bonds at the current market price because they are currently under or overpriced. Please select one of each.

Answer 1

(a)-The Yield to maturity of (YTM) of the Bond

• The Yield to maturity of (YTM) of the Bond is the discount rate at which the Bond’s price equals to the present value of the coupon payments plus the present value of the Face Value/Par Value
• The Yield to maturity of (YTM) of the Bond is the estimated annual rate of return expected by the bondholders for the bond assuming that the they hold the Bonds until it’s maturity period/date.
• The Yield to maturity of (YTM) of the Bond is calculated using financial calculator as follows (Normally, the YTM is calculated either using EXCEL Functions or by using Financial Calculator)

Variables	Financial Calculator Keys	Figure
Par Value/Face Value of the Bond [$1,000]	FV	1,000
Coupon Amount [$1,000 x 7.00%]	PMT	70
Market Interest Rate or Yield to maturity on the Bond	1/Y
Maturity Period/Time to Maturity [12 Years]	N	12
Bond Price/Current Market Price of the Bond [-$885]	PV	-885

We need to set the above figures into the financial calculator to find out the Yield to Maturity of the Bond. After entering the above keys in the financial calculator, we get the annual yield to maturity (YTM) on the bond = 8.57%.

“Hence, the Yield to maturity of (YTM) of the Bond will be 8.57%”

(b)-The value of the Bond at market's required yield to maturity on a​ comparable-risk bond rate of 10.00%.

• The Price of the Bond is the Present Value of the Coupon Payments plus the Present Value of the Face Value/Par Value.
• The Price of the Bond is normally calculated either by using EXCEL Functions or by using Financial Calculator.
• Here, the calculation of the Bond Price using financial calculator is as follows

Variables	Financial Calculator Keys	Figure
Par Value/Face Value of the Bond [$1,000]	FV	1,000
Coupon Amount [$1,000 x 7.00%]	PMT	70
Market Interest Rate or Yield to maturity on the Bond [10.00%]	1/Y	10
Maturity Period/Time to Maturity [12 Years]	N	12
Bond Price/Current Market Price of the Bond	PV	?

Here, we need to set the above key variables into the financial calculator to find out the Price of the Bond. After entering the above keys in the financial calculator, we get the Price of the Bond (PV) = $795.59.

“Hence, the Price of the Bond will be $795.59”

(c)-Decision

You “SHOULD” purchase the Smith bonds at the current market price because they are currently “UNDERPRICED”.