Question

12. MJI Corporation bonds mature in 6 years and have a yield to maturity of 8.5 percent. The par value of the bonds is $1,000. The bonds have a 10 percent coupon rate and pay interest on a semi-annual basis. Assuming there are no changes to interest rates during the course of the year, what are the current yield and capital gains yield on the bonds for this year?

13. Bond Relationships. Select one or more of the following phrases to complete the following sentences. increase , decrease, par, discount, premium, less than, more than, greater , less

a. If the current interest rate exceeds the bond’s coupon rate, the bond will sell at a ___________.

b. The value of a bond to increase if there is a/an ________ in interest rates.

c. A bond’s coupon rate is more than the interest rate, therefore the bond is selling at a _____________.

d. As interest rate increases the value of a bond will ______________.

e. If the bondholder’s required rate of return equals the coupon interest rate, the bond will sell at _________.

f. A premium bond sells for ____________ as maturity approaches.

g. The discount bond sells for ____________ as maturity approaches.

h. A bondholder with a short-term bond is exposed to ___________ interest rate risk than when owing a long-term bond.

Answer 1

Part 12

To calculate capital gains yield and the current yield, the current price of Bond and the price of Bond are derived.

Current Price of bond = present of coupon payments + present of face value

=(50*((1-(1.0425^-12))/(4.25%)))+(1000/(1.0425^12)) = $1069.38

Price of bond in one year time =(50*((1-(1.0425^-10))/(4.25%)))+(1000/(1.0425^10)) = $1060.08

Current yield = 100/1069.38 = 9.35%

Capital gain yield = (New price – Original price) / Original price = (1060.08-1069.38)/1069.38 = -0.87%

Part 13

a. If the current interest rate exceeds the bond’s coupon rate, the bond will sell at a discount.

b. The value of a bond to increase if there is a/an decrease in interest rates.

c. A bond’s coupon rate is more than the interest rate, therefore the bond is selling at a premium.

d. As interest rate increases the value of a bond will decrease.

e. If the bondholder’s required rate of return equals the coupon interest rate, the bond will sell at Par.

f. A premium bond sells for less than as maturity approaches.

g. The discount bond sells for more than as maturity approaches.

h. A bondholder with a short-term bond is exposed to less interest rate risk than when owing a long-term bond.