Harold Reese must choose between two bonds: Bond X pays $92 annual interest and

Question

Harold Reese must choose between two bonds: Bond X pays $92 annual interest and has a market value of $895. It has 10 years to maturity. Bond Z pays $82 annual interest and has a market value of $920. It has four 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 10.94 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

Current yield = Annual interest/current price

Bond X:

Current yield = 92/895 = 10.28%

Bond Z:

Current yield = 82/920 = 8.91%

b.

Choose Bond X as it has higher current yield.

c.

Approximate YTM:

YTM = [C + (F-P)/n] / [(F+P)/2]

C - Coupon

F - face value

P - price

n - years to maturity

YTM = (82 + (1000-920)/4) / ((1000+920)/2) = 10.625%

Exact YTM:

PV = 920

PMT = 82

N = 4

FV = 1000

CPT-> I/Y = 10.77%

d. No. Even in this case YTM is higher for Bond X. So the answer does not change.

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