1 answer

Bond A is a 12-year 7% annual coupon bond. Bond B is a 12-year 9% annual...

Question:

Bond A is a 12-year 7% annual coupon bond. Bond B is a 12-year 9% annual coupon bond. Bond C is a 12-year 11% annual coupon bond. Each of these three bonds has a yield to maturity (YTM) of 9%. Assume the market rate of interest does not change over time.

- Is the capital gains yield (CGY) earned on Bond A greater than the CGY on Bond C? Explain.

- Is the interest yield (IY) on Bond A in year 2 greater than the IY on Bond C in year 2? Explain.


Answers

- Is the capital gains yield (CGY) earned on Bond A greater than the CGY on Bond C? Explain.

Yes, Capital gains yield (CGY) earned on Bond A greater than the CGY on Bond C because Bond A is a discount bond (coupon rate is less than its yield to maturity); therefore price of bond A will increase with date of maturity approaching. While Bond C is a Premium bond (coupon rate is more than its yield to maturity); therefore price of bond C will decrease with date of maturity approaching.

Capital gains yield (CGY) = (P1 –P0) /P0 *100

- Is the interest yield (IY) on Bond A in year 2 greater than the IY on Bond C in year 2? Explain.

No, the interest yield (IY) on Bond A in year 2 is lower than the IY on Bond C in year 2 because the coupon rate of Bond A is lower than Bond C therefore interest paid on Bond A is lower than Bond C. Therefore the interest yield (IY) on Bond A in year 2 is lower than the IY on Bond C in year 2.

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