A $1,000 par value bond is for sale. Its coupon rate is 3.50% and it will be out

Question

A $1,000 par value bond is for sale. Its coupon rate is 3.50% and it will be outstanding for 4 years.

Current rates (discount rate or opportunity cost of money) are only 2.20%.

- Question 1: Without doing any math, do you think the price (value) of this bond is going to be higher or lower than $1,000 ?

- Question 2: Now, do the math. What is the market price of this bond, given the above facts?

- Question 3: Would you predict the current yield on this bond to be higher or lower than the coupon rate?

- Question 4: What is the current yield on this bond ?

- Question 5: Would you expect the Yield to Maturity of this bond to be higher or lower than its coupon rate?

- Question 6: Would you expect the Yield to Maturity of this bond to be higher or lower than its current yield?

- Question 7: Calculate the Yield to Maturity of this bond.

Explanation / Answer

1) a bond with a higher coupon rate than the market rate of interest tends to raise in price. If the general interest rate is 2.20% but the coupon is 3.50%, investors rush to purchase the bond to achieve a higher return on their investment.
2)

3) The current yield on this bond is lower than the coupon rate because the bond is trading at a premium to its face value.


4) Current Yield = PMT/ current Price = $35/$1049.26 = 3.34%

Face Value(FV) $1,000 Coupon Rate 3.50% Coupon payment (PMT) (1000 x 6.5%) $35 Nper 4 Rate 2.20% Price of the Bond (PV(2.20%,4,-35,-1000) $1,049.26

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