The Brownstone Corporation bonds have 5 years remaining to maturity. Interest is paid annually; the bonds have a $1,000 par value; and the coupon interest rate is 9%.
a) What is the yield to maturity at a current market price of (1) $829 or (2) $1,104?
b) Would you pay $829 for one of these bonds if you thought that the appropriate rate of interest was 12% - that is, if rd = 12%?
Explain your answer and show all formulas used.
a
1
| K = N |
| Bond Price =∑ [(Annual Coupon)/(1 + YTM)^k] + Par value/(1 + YTM)^N |
| k=1 |
| K =5 |
| 829 =∑ [(9*1000/100)/(1 + YTM/100)^k] + 1000/(1 + YTM/100)^5 |
| k=1 |
| YTM% = 13.98 |
2
| K = N |
| Bond Price =∑ [(Annual Coupon)/(1 + YTM)^k] + Par value/(1 + YTM)^N |
| k=1 |
| K =5 |
| 1104 =∑ [(9*1000/100)/(1 + YTM/100)^k] + 1000/(1 + YTM/100)^5 |
| k=1 |
| YTM% = 6.5 |
b
| K = N |
| Bond Price =∑ [(Annual Coupon)/(1 + YTM)^k] + Par value/(1 + YTM)^N |
| k=1 |
| K =5 |
| Bond Price =∑ [(9*1000/100)/(1 + 12/100)^k] + 1000/(1 + 12/100)^5 |
| k=1 |
| Bond Price = 891.86 |
Yes because market price is lower than intrinsic price at 12% interest rate
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