An investor must choose between two bonds: Bond A pays $92 annual interest and h
ID: 2807420 • Letter: A
Question
An investor must choose between two bonds:
Bond A pays $92 annual interest and has a market value of $825. It has 15 years to maturity.
Bond B pays $83 annual interest and has a market value of $720. It has seven 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 A Bond B b. Which bond should she select based on your answers to part a? Bond B Bond A 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 A is 11.58 percent. What is the approximate yield to maturity on Bond B? 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 in terms of which bond to select? No YesExplanation / Answer
Current Yield = Interest paid / Current bond price
Bond A,
Current Yield = 92 / 825 = 0.1115 = 11.15%
Bond B,
Current Yield = 83 / 720 = 0.11527 = 11.53%
Based on Current Yield, Bond B should be selected.
Yield to Maturity of Bond B :
720 = 83 * PVAF(7y,YTM) + 1,000 * PVF(7y,YTM)
At 15%, Value of BOnd B = 83 * 4.160 + 1,000 * 0.376 = 721.28
At 16%, = 83 * 4.039 + 1,000 * 0.354 = 689.24
As the current market value of the bond $720 lies between YTM of 15% and 16%. Hence, the Yield to maturity of the Bond B is between 15%and 16%.
YTM of Bond B = 15% + (721.28 - 720) / (721.28 - 689.24) = 15% + 1.28 / 32.04 = 15.04%
Based on YTM also, Bond B should be selected.
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