Chapter 6, Problem 1QP

a)

Summary Introduction

To determine: The current yield and yield to maturity of 2028 maturity bond.

Yield to maturity (YTM) is the overall return anticipated on a bond throughout its maturity period and it is considered as a long-term bond yield and represented as an annual rate.

Explanation of Solution

Computation of current yield is as follows:

The bond providing an interest of 5.25% and the annual interest will be $52.50 $\left(\$1,000\times 5.25\%\right)$ and the selling price of bond is $1,304,531. therefore, the current yield is as follows:

$\begin{array}{c}\text{Current yield}=\frac{\text{Annual interest}}{\text{Bond price}}\\ =\frac{\$52.50}{\$1,304.531}\\ =0.0402\text{or 4}\text{.02\%}\end{array}$

Therefore, the current yield is 4.02%.

b)

Summary Introduction

To determine: The statement that “the current yield is less than the yield to maturity whenever the bond price is greater than the face value”. True or false.

Explanation of Solution

False, since the bond is selling at premium the yield to maturity on the bond is lower than that of the current yield. While reaching the maturity period the holder will give only $1,000 face value, after deducting the total return on investment.