Chapter 10, Problem 18PS

Summary Introduction

Introduction:

A bond is a security that creates an obligation on the issuer to make specified payments to the holder for a given period of time. The face value of the bond is the amount the holder will receive on maturity along with the coupon rate which is also known as the interest rate of the bond. Yield to maturity is defined as the discount rate that makes the present payments from the bond equal to its price. In simple terms, it is the average rate of return a holder can expect from a bond. Current yield is a bond's annual income divided by the current price of the security. Horizon yield is the total return when a bond is sold prior to maturity.

To Discuss:

Bonds of Zello Corporation with a par value of $1000 sell for $960, mature in five years and have a 7% annual coupon rate paid annually. The reasoning for lower yields in this case is to be given.

Calculate the:

1. Current Yield
2. Yield to maturity
3. Horizon yield for an investor with a three 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%.