3. Malcolm must choose between two bonds: Bond X pays $85 annual interest and ha

Question

3. Malcolm must choose between two bonds: Bond X pays $85 annual interest and has a market value of $825. It has 10 years to maturity. Bond Z pays $85 annual interest and has a market value of $845. It has two years to maturity. a. Compute the current yield on both bonds (3pts). b. Which bond should he select based on your answer to part a (3pts)? c. A drawback of current yield is that it does not consider the total life of the bond. For example, the yield to maturity on Bond X is 11.54 percent. What is the yield to maturity on Bond Z (3pts)?

Explanation / Answer

a)current yield for bond X

Coupon payment/current market price=85/825=0.103~10.3%

current yield for bond Z

=> Coupon payment/current market price= 85/845 =0.1005~10.05%

b) Bond X since it has a higher current yield.

c)Yield to maturity=( annual interest payments+(Principal payment-price of bond)/2)/(0.6)*(price of bond)+(0.4*principle of bond)

YTM=(85+(1000-845)/2)/(0.6*845+0.4*1000)

=0.179~17.9%

d)Yes since bond Z has a higher yield to maturity.this is because the $155 will be recovered in two years. with bondX there is 10 year period.

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