Question

Q1.  A company is about to issue some bonds. Each bond has a coupon rate of 6.5% A maturity date of 1st June 2015 A Yield to Maturity of 4.875% and the coupon frequency is annual. If today is 1st June 2010

a) What should be the issue price?

b) What is the current yield of the bond in part (a) and why is it not the same as the yield to maturity?

Answer 1

a). Bond's Issue Price = PV of Coupon Payment + PV of Maturity Value

= [Periodic Coupon Payment * {(1 - (1 + r)^-n) / r}] + [Face Value / (1 + r)^n]

= [{6.5%*$1,000} * {(1 - (1 + 0.04875)^-5) / 0.04875}] + [$1,000 / {1 + 0.04875}^5]

= [$65 * {0.2118 / 0.04875}] + [$1,000 / 1.2687]

= [$65 * 4.3445] + $788.21

= $282.39 + $788.21 = $1,070.60

b). Current Yield = Annual Coupon Payment / Current Bond Price

= [6.5%*$1,000] / $1,070.60 = $65 / $1,070.60 = 0.0607, or 6.07%

Unlike Current Yield, YTM accounts for the present value of a bond's future coupon payments.