3. Bond yields and prices over time Aa Aa A bond investor is analyzing the follo

Question

3. Bond yields and prices over time Aa Aa A bond investor is analyzing the following annual coupon bonds: Issuing Company Smith Enterprises Irwin Incorporated Johnson Metalworks Annual Coupon Rate 5% 12% 9% Each bond has 10 years until maturity and has the same risk. Their yield to maturity (YTM) is 9%. Interest rates are assumed to remain constant over the next 10 years. Label the curves on the following graph to indicate the path that each bond's price, or value, is expected to follow BOND VALUE($ 1200 1100 1000 900 800 700 600 10 YEARS TO MATURITY

Explanation / Answer

If coupan rate is greater than tym, bond trades at premium and if ytm is greater than coupan rate , bond trades at discount.

The diagram in question depicts Constant Price yield trajectory which shows the relationship between price and maturity ( yield remains constant).

The orange curve shows the premium bond I.e.,bond issued by Irwin Incorporated.

The green curve shows the par bond ie., Bond issued by Johnson metal works.

The blue curve shows the discount bond, I.e., bonds issued by Smith enterprise

Based on the above diagram following statements are true:

Johnson bond selling at par.

Current yield of Irwin bind is greater than 9%

120 PMT, 1000FV, 10 N, 9 I/Y PV CPT Price= 1192 appx.

CY= Annual coupan/ Price = 120/ 1192= 10.06% appx which is greater than 9 %.

If the bond is selling for a price much lower than its par value, it is most likely that the bond is discount bond.

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