Bond Valuation Essay
Clifford Clark is a recent retiree who is interested in investing some of his savings in corporate bonds. His financial planner has suggested the following bonds:
• Bond A has a 7% annual coupon, matures in 12 years, and has a $1000 face value.
• Bond B has a 9% annual coupon, matures in 12 years, and has a $1000 face value.
• Bond C has an 11% annual coupon, matures in 12 years, and has a $1000 face value.
Each bond has a yield to maturity (YTM) of 9%.
1) Without calculation, indicate whether each bond is trading at a premium, discount, or at par.
In order to indicate whether each bond is trading at a premium, discount, or at par, you need to compare the yield to maturity (YTM). If the …show more content…
Bond A: CGYA = (P1-P0)/P0 = (863.90 – 856.79) / (856.79) = 0.0083 = .83%
Bond B: CGYB = (P1-P0)/P0 = (1000.00 – 1000.00) / (1000.00) = 0.0000 = 0%
Bond C: CGYC = (P1-P0)/P0 = (1136.10 – 1143.21) / (1143.21) = -0.0062 = -.62%
The expected total return on each bond in year 1;
The expected total return (TR) on a bond is the sum of the current yield and the expected capital gains yield. Calculations for the expected capital gains yield are provided above. In order to calculate the expected current yield (CY), simply divide the coupon payment (INT) by the beginning price (P0). The formula the book has is as follows: TR = CY + CGY
Bond A: TRA = CYA + CGYA = (70 / 856.79) + .83% = 8.17% + .83% = 9%
Bond B: TRB = CYB + CGYB = (90 / 1000.00) + 0% = 9% + 0% = 9%
Bond C: TRC = CYC + CGYC = (110 / 1143.21) - .62% = 9.62% - .62% = 9%