Question

5. Eleven years from now the bond will have 1 year until maturity. Assume market interest rates are at 7 percent, the same place they were when the bond was issued. Given this: k. What will be the bond's price 11 years from now? 1. What will be the current yield eleven years from now? m. What is the expected capital gains yield eleven years from now? n. How does you answers to part (1) and (m) compare with your answers to parts (b) and (c)?

Answer 1

Solution:

5.Assuming face value of bond is $1000

k)Calculation of price of bond 11 years now;

Price of bond=Present value of coupon for last year+Present value of Maturity amount

=($1000*10%)*PVIF(7%,1)+$1000*PVIF(7%,1)

=$100*0.934579+$1000*0.934579

=$1028.04

l)Calculation of Current yield 11 years now;

Current yield=Annual coupon/Current bond price

=$100/$1028.04

=0.0973 or 9.73%

m)Calculation of expected capital gain yield

Capital Gain yield=[(Current price-Original price)/Original price]*100

=[($1028.04-$1038.28)/$1038.28]*100

=-0.99%

n)As the maturity years decreases,the bond price is decreases, which result in higher current yield.Therefore current yield 11 years now is higher than the current yield for year 1.

Further,Capital gain yield is higher due to higher price of bond in year 11 as compared to bond price in year 2.