Question

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7-9. YIELD TO MATURITY Harrimon Industries bonds have 6 years left to maturity. Interest is paid annually, and the bonds have a $1,000 par value and a coupon rate of 10%. a. What is the yield to maturity at a current market price of (1) $865 and (2) $1,166? b. Would you pay $865 for each bond if you thought that a “fair” market interest rate for such bonds was 12%—that is, if ra = 12%? Explain your answer.

Answer 1

a.1. Information provided:

Par value= future value= $1,000

Coupon rate= 10%

Coupon payment= 0.10*1,000= $100

Time= 6 years

Current price= present value= $865

The yield to maturity is calculated by entering the below in a financial calculator:

FV= 1,000

PV= -865

N= 6

PMT= 100

Press the CPT key and I/Y to compute the yield to maturity.

The value obtained is 13.42.

Therefore, the yield to maturity is 13.42%.

a.2. Information provided:

Par value= future value= $1,000

Coupon rate= 10%

Coupon payment= 0.10*1,000= $100

Time= 6 years

Current price= present value= $1,166

The yield to maturity is calculated by entering the below in a financial calculator:

FV= 1,000

PV= -1,166

N= 6

PMT= 100

Press the CPT key and I/Y to compute the yield to maturity.

The value obtained is 6.56.

Therefore, the yield to maturity is 6.56%.

b. I would not pay 12% for such bonds since the fair market rate here is 13.42%.

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