Chapter 6, Problem 13PROB

Summary Introduction

Bond has a face value of $1,000 currently trading at $714.The bond has a coupon rate of 4% paid semi-annually with 16 years left to maturity.

Yield to maturity (YTM) of a bond is the required rate of return expected on holding the bond till maturity. When the YTM of the bond is higher than the coupon value, the bond is said to be trading at a discount and when it is lower than the coupon value, then the bond is trading at a premium.

YTM calculation is a trial and error process, however, we can calculate YTM using a financial calculator as follows:

INT = PMT = coupon amount

FV = M = maturity value

PV = Price of the bond (input as a negative value)

N = number of periods

Yield to Call (YTC) on the other hand, is the rate of return which the investors expect if the bond is redeemed or called before the maturity period. YTC is generally higher than YTM, since the bondholders are not able to earn interest on the period between the time when bond is called and the maturity time. The calculation is same as the YTM of the bond except that in the maturity value, call price of the bond is used

We can calculate YTM using a financial calculator as follows:

INT = PMT = coupon amount

FV = CP = call price

PV = Price of the bond (input as a negative value)

N = number of periods