Question

The 12​-year, ​$1,000 par value bonds of Waco Industries pay 12 percent interest annually. The market price of the bond is ​$955​, and the​ market's required yield to maturity on a​ comparable-risk bond is 14 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?

Round to nearest two decimal places:

Answer 1

(a) Price of bond (PV) = -$955

Par value of bond (FV) = $1000

Annual coupon payment (PMT) = $1000 * 12% = $120

No of annual coupon payments pending to be received (N) = 12

Therefore Yield to maturity (Y) = ??

Using financial calculator or rate function in excel,

Yield to maturity (Y) = 12.752% p.a.

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

Annual coupon payment (PMT) = $1000 * 12% = $120

No of annual coupon payments pending to be received (N) = 12

Yield to maturity of comparable bond (Y) = 14%

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) = $ 886.79

(c) We should not purchase the bond. Since the bond is overpriced. It is trading at $955 whereas it has value of $886.79

Or you can say yield to maturity of bond is 12.75% which is less than yield of comparable bond 14%.

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