Question

The 16-year, $1,000 par value bonds of Waco Industries pay 7 percent interest annually. The market price of the bond is $875, and the market's required yield to maturity on a comparable -risk bond is 10 percent. a. Compute the bond's yield to maturity. b. Determine the value of the bond to you given the market's required yield to maturity on a comparable-risk bond. c. Should you purchase the bond?.

Answer 1

Answer a.

Par Value = $1,000
Current Price = $875

Annual Coupon Rate = 7.00%
Annual Coupon = 7.00% * $1,000
Annual Coupon = $70

Time to Maturity = 16 years

Let Annual YTM be i%

$875 = $70 * PVIFA(i%, 16) + $1,000 * PVIF(i%, 16)

Using financial calculator:
N = 16
PV = -875
PMT = 70
FV = 1000

I = 8.45%

Annual YTM = 8.45%

Answer b.

Par Value = $1,000
Annual Coupon = $70
Time to Maturity = 16 years

Annual Comparable Yield = 10%

Value of Bond = $70 * PVIFA(10%, 16) + $1,000 * PVIF(10%, 16)
Value of Bond = $70 * (1 - (1/1.10)^16) / 0.10 + $1,000 / 1.10^16
Value of Bond = $765.29

Answer c.

The current market price of bond is higher than the value of bond with comparable-risk bond. Therefore, you should not purchase this bond.