1 answer

Denton is considering purchasing a 7-year bond that is selling for $1,017. Which of the following...

Question:

Denton is considering purchasing a 7-year bond that is selling for $1,017. Which of the following is correct if this bond has
Denton is considering purchasing a 7-year bond that is selling for $1,017. Which of the following is correct if this bond has a 2.5% coupon, paid semiannually? a. The YTM < coupon rate. b. The current yield > coupon rate c. The current yield < YTM. d. All the above.

Answers

The correct answer is (a) The YTM < Coupon Rate

Reasoning:

Formula for YTM - F -P . YTM=C+ /F+P)/2

where, C is Coupon (assuming par value is $1000, coupon amount is $25); F is Face Value (Assumed $1000); P is Current Price ($1017); N is period (i.e. 14 since semi-annual compounding).

Hence, on solving the equation, YTM derived is 2.35 which is less than Coupon rate.

Formula for Current Yield - CurrentYield = Coupon Price

Hence, CY is 2.46% (25/1017), which is less than Coupon rate and more than YTM. Hence, the answer is not b,c, or d.

Thank you.

.

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