Question
First, we need to determine the cash flows for this bond. It has a coupon rate of 2.50%, a par value of $1000, and pays
First, we need to determine the cash flows for this bond. It has a coupon rate of 2.50%, a par value of $1000, and pays coupons semi-annually for ten years. Therefore, it will make 20 coupon payments of $12.50 each ($25 per year divided by two semi-annual payments) and a final payment of $1000 at maturity.
Next, we need to calculate the present value of all the cash flows. We can use a financial calculator or spreadsheet software to do this calculation. The present value of the coupon payments can be calculated using the formula for the present value of an annuity:
PV = C x [1 - (1 + r)^(-n)]/r
where PV is the present value, C is the coupon payment, r is the periodic interest rate, and n is the number of periods.
For this bond, C = $12.50, r = YTM/2 (since it pays semi-annually), and n = 20. We also need to add the present value of the final payment of $1000, which is just $1000/(1+YTM/2)^20.
The total present value of the cash flows is then:
PV = $12.50 x [1 - (1 + YTM/2)^(-20)]/(YTM/2) + $1000/(1+YTM/2)^20
We can then set this equal to the current market price of $963.828 and solve for YTM using trial and error or a financial calculator:
$963.828 = $12.50 x [1 - (1 + YTM/2)^(-20)]/(YTM/2) + $1000/(1+YTM/2)^20
YTM = 2.622%
Therefore, the yield to maturity for this bond is approximately 2.622%.
Help with-
Calculate the bond's value directly (using the present value approach) assuming that rates declined 0.80% from the yield to maturity you estimated in the first question. (the first question solution is above)
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