Harold Reese must choose between two bonds: Bond X pays $95 annual interest and

Question

Harold Reese must choose between two bonds: Bond X pays $95 annual interest and has a market value of $905. It has 13 years to maturity. Bond Z pays $85 annual interest and has a market value of $910. It has five years to maturity. Assume the par value of the bonds is $1,000. a. Compute the current yield on both bonds. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.) Current Yield Bond X % Bond Z % b. Which bond should he select based on your answers to part a? Bond X Bond Z c. A drawback of current yield is that it does not consider the total life of the bond. For example, the approximate yield to maturity on Bond X is 10.85 percent. What is the approximate yield to maturity on Bond Z? The exact yield to maturity? (Use the approximation formula to compute the approximate yield to maturity and use the calculator method to compute the exact yield to maturity. Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.) Approximate yield to maturity % Exact yield to maturity % d. Has your answer changed between parts b and c of this question? Yes No

Explanation / Answer

a)

current yield of bond x = annual interest/market value

current yield of bond x = 95/905

current yield of bond x = 10.50%

current yield of bond Z = annual interest/market value

current yield of bond Z = 85/910

current yield of bond Z = 9.34%

b)

Bond X should be selected based on current yield

c)

Bond Z

Approximate yield to maturity = (Annual Coupon + (Maturity value - Current price)/period)/ ( (Maturity value+ Current price)/2)

Approximate yield to maturity = (85+ (1000-910)/5)/((1000+910)/2)

Approximate yield to maturity = 10.79%

Exact yield to maturity = rate(nper,pmt,pv,fv)

Exact yield to maturity = rate(5,85,-910,1000)

Exact yield to maturity = 10.93%

d)

Yes ,  answer would changed between parts b and c of this question as  A drawback of current yield is that it does not consider the total life of the bond

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