Problem 4 - Bonds You recently inherited from your late uncle a US government bo

Question

Problem 4 - Bonds
You recently inherited from your late uncle a US government bond that matures December 31, 2025. The bond has a face value of 20,000 USD, which is equal to its redemption value. It pays an annual interest of 8%, payable semi-annually (i.e. as 4%) on June 30 and December 31 of each year. Answer the following question by performing your calculations both analytically and by using the relevant Excel functions.

e) If the bond trades for 17,988 USD in the market on July 1, 2016, what is the implied bond-yield rate?

Explanation / Answer

Given that:

The bond has a face value of 20,000 USD, which is equal to its redemption value. It pays an annual interest of 8%, payable semi-annually (i.e. as 4%) on June 30 and December 31 of each year.

Thus, the bond interest is $800 i.e. $20,000 × 4%

If the bond trades for 17,988 USD in the market on July 1, 2016, the implied bond-yield rate is:

Bond Yield rate = Coupon amount ÷ Market rate of bond

                        = $800 ÷ $17,988

           = 0.0447 or 4.45%

Therefore, the bond yield rate would be 4.45%

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