Suppose you are considering investing in a 5-year, 11%coupon, 51000 face value bond trading for $1294.73....

Question

Question

Answer 1

Answer #1

Bond’s yield to maturity can be calculated with the help of following formula

Bond price P0 = C* [1- 1/ (1+i) ^n] /i + M / (1+i) ^n

Where

Price of the bond P0 = $1294.73

M = value at maturity, or face value = $ 1000

C = coupon payment = 11% of $1000 = $110

n = number of payments = 5 (years)

i = interest rate, or yield to maturity =?

Now we have,

$1294.73 = $ 110 * [1 – 1 / (1+i) ^5] /i + $1000 / (1+i) ^5

By trial and error method we got the value of i = 4.32%

[Or you can use excel function for YTM calculation in following manner

“=Rate(N,PMT,PV,FV)”

“=Rate(5,-110,1294.73,-1000)” = 4.32%]

Therefore correct answer is option a. 4.32%

Answer 2

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