Question

A bond offers a coupon rate of 6%, paid annually, and has a maturity of 9 years. The current market yield is 14%. If market conditions remain unchanged, what should be the Capital Gains Yield of the bond?

Answer 1

Step-1:Calculation of Current price of bond
	Present value of coupon			$     296.78
	Present value of Par value			$     307.51
	Present value of cash flows			$     604.29
	So, the price of bond is			$     604.29
Working:
# 1	Annual coupon		=	Par Value * Coupon rate
			=	1000*6%
			=	$       60.00
# 2	Present value of annuity of 1		=	(1-(1+i)^-n)/i		Where,
			=	(1-(1+0.14)^-9)/0.14		i	14%
			=	4.9463718		n	9
# 3	Present value of 1		=	(1+i)^-n
			=	(1+0.14)^-9
			=	0.3075079
# 4	Present value of coupon		=	Coupon * Present value of annuity of 1
			=	$       60.00	*	4.946372
			=	$     296.78
# 5	Present value of Par value		=	Par Value * Present value of 1
			=	$ 1,000.00	*	0.307508
			=	$     307.51
Step-2:Calculation of dividend yield
	Dividend yield		=	Annual coupon / Current Price
			=	$       60.00	/	$ 604.29
			=	9.93%
Step-3:Calculation of Capital gain yield
	Capital gain yield		=	Market yield	-	Dividend yield
			=	14.00%	-	9.93%
			=	4.07%
Thus,
	Capital gain yield is 4.07%