Question

Bonds of Zello Corporation with a par value of $1,000 sell for $960, mature in five years, and have a 7% annual coupon rate paid semiannually. a. Calculate the: i. Current yield. ii. Yield to maturity to the nearest whole percent (i.e., 3%, 4%, 5%, etc.). iii. Realized compound yield for an investor with a 3-year holding period and a reinvestment rate of 6% over the period. At the end of three years the 7% coupon bonds with two years remaining will sell to yield 7%. b. Cite one major shortcoming for each of the following fixed-income yield measures: i. Current yield. ii. Yield to maturity. iii. Realized compound yield.

Answer 1

Answer and Step by Step Explanation:

a i)Current yield = Coupon/Price = $70/$960 = 0.0729 = 7.29%

ii. Yield to maturity (to the nearest whole percent, i.e., 3%, 4%, 5%, etc.)

YTM = 3.993% semiannually or 7.986% annual bond equivalent yield.On a financial calculator, enter: n = 10; PV = –960; FV = 1000; PMT = 35

iii.

Realized compound yield is 4.166% (semiannually), or 8.332% annual bond equivalent yield.

Therefore to get this value, we would find the future value (FV) of reinvested coupons and principal in which there will be six payments of$35 each, reinvested semiannually at 3% per period.

PV = 0; PMT = 35; n = 6; i = 3%. Compute: FV = 226.39

Three years from now, the bond will be selling at the par value of $1,000 because the yield to maturity is forecast to equal the coupon rate. The total proceeds in three years will be: $226.39 + $1,000 =$1,226.39

The rate (yrealized) that makes the FV of the purchase price equal to $1,226.39: $960 * (1 + yrealized)6= $1,226.39

yrealized= 4.166% (semiannual)

b . i. Current yield. Current yield can be defined as the way capital gains or losses on bonds bought at prices , reinvestment income on coupon payments are not account for other than par value.

ii. Yield to maturity can be seen as the bond which is held until maturity and that all coupon income can be reinvested at a rate equal to the yield to maturity

iii. Realized compound yield are yield that is affected by the forecast of reinvestment rates, holding period, and yield of the bond at the end of the investor's holding period