An investor must choose between two bonds: Bond A pays $100 annual interest and

Question

An investor must choose between two bonds:
Bond A pays $100 annual interest and has a market value of $850. It has 12 years to maturity.
Bond B pays $106 annual interest and has a market value of $920. It has 4 years to maturity.
Assume the par value of the bonds is $1,000

a. compute the current yield on both bonds (%)
Bond A
Bond B

b. Which bond should he select based on your answer to part a?

c. A drawback of current yield is that it does not consider the total life of the bond. For example, he approximate yield to maturity on Bond A is 12.36%. What is the approximate yield to maturity on Bond B? (%)

d. Has your answer changed between parts b and c of this question in terms of which bond to select? (yes or no)

Explanation / Answer

Bond A yield = 100/850 = 11.76%

Bond B yield = 106/920 = 11.52%

b) bond A because it has higher current yield

c) yieldto maturity = (106 + ((1000-920)/2)) / (0.6 *920 + 0.4 * 1000) = 15.34%

d) yes,now Bond B has higher yield to maturity

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