Question
If the terms of a bond do not allow the issuer to buy the bond back early, you can use the ______ to estimate the
If the terms of a bond do not allow the issuer to buy the bond back early, you can use the ______ to estimate the bonds rate of return.
Suppose you were offered a 14-year, 8% annual coupon, $1,000 par value bond at a price of $1,422.52. If you bought the bond, held it to maturity, and received the promised interest payments and maturity value, the rate of interest you would earn is called the bonds yield to maturity (YTM). The yield to maturity is the value for rd that solves the following equation:
VB | = = | INT(1+rd)1+INT(1+rd)2+...+INT(1+rd)N+M(1+rd)NINT1+1+INT1+2+...+INT1++1+ |
$1,422.52$1,422.52 | = = | $80(1+rd)1+$80(1+rd)2+...+$80(1+rd)14+$1,000(1+rd)14$801+1+$801+2+...+$801+14+$1,0001+14 |
Where:
VB: | the bonds value or price |
rd: | the market rate of interest on the bond |
N: | the number of years before the bond matures |
INTINT: | the dollars of interest paid each year, which equals the coupon rate times the par value of the bond |
M: | par, or maturity, value of the bond |
To solve for rd, you could use trial and error until you find a value that results in the sum of the present values equaling the price of the bond, but that would be tedious and time consuming. On the other hand, you can use a financial calculator to solve for I/Y:
Input | 14 | -$1422.52 | $80 | $1,000 | |
Keystroke | N | I/Y | PV | PMT | FV |
Output | 4 |
Holding all else constant, a higher bond price results in a __________ yield to maturity.
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