Bonds of Francesca Corporation with a par value of $1,000 sell for $960, mature in five years, and have a 7 percent annual coupon rate paid semiannually.
a. Calculate the:
(1) Current yield
(2) Yield to maturity (to the nearest whole percent—that is, 3 percent, 4 percent, 5 percent, etc.)
(3) Horizon yield (also called realized or total return) for an investor with a three-year holding period and a reinvestment rate of 6 percent over the period. At the end of three years, the 7 percent coupon bonds with two years remaining will sell to yield 7 percent.
Show your work.
b. Cite one major shortcoming for each of the following fixed-income yield measures:
(1) Current yield
(2) Yield to maturity
(3) Horizon yield (also called realized or total return)