Question

The 18​-year, ​$1,000 par value bonds of Waco Industries pay 7 percent interest annually. The market price of the bond is ​$925​, and the​ market's required yield to maturity on a​ comparable-risk bond is 9 percent.

a.Compute the​ bond's yield to maturity.

b.Determine the value of the bond to you given the​ market's required yield to maturity on a​ comparable-risk bond.

c.Should you purchase the​ bond?

Answer 1

(a) Price of bond (PV) = -$925

Par value of bond (FV) = $1000

Annual coupon payment (PMT) = $1000 * 7% = $70

No of annual coupon payments pending to be received (N) = 18

Therefore Yield to maturity (Y) = ??

Using financial calculator or rate function in excel,

Yield to maturity (Y) = 7.79% p.a.

(b) Par value of bond (FV) = $1000

Annual coupon payment (PMT) = $1000 * 7% = $70

No of annual coupon payments pending to be received (N) = 18

Yield to maturity of comparable bond (Y) = 9%

Value of bond based on comparable risk bond (PV) = ??

Using financial calculator or PV function in excel,

Value of bond based on comparable risk bond (PV) = $ 824.89

(c) We should not purchase the bond. Since the bond is overpriced. It is trading at $925 whereas it has value of $825.

Or you can say yield to maturity of bond is 7.79% which is less than yield of comparable bond.

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