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You are considering purchasing two bonds (Bond X and Bond Y) issued by ABC Inc. Both bonds have 10 years remaining to maturity and $1,000
You are considering purchasing two bonds (Bond X and Bond Y) issued by ABC Inc. Both bonds have 10 years remaining to maturity and $1,000 par value but carry different coupon rates: Bond X carries 5% coupon while Bond Y 7%. Bond X is an annual coupon-paying bond whereas Bond Y is a semi-annual coupon-paying bond.
(a) Explain, without the calculation of the bond price, whether Bond X and Bond Y are trading at a premium, par or discount if their current YTMs are both 7%. [Note: Correct answer would only be given full mark if it is NO more than THREE lines.] (2 marks)
(b) Continued with (a). At what price is Bond X currently trading at? (4 marks)
(c) Suppose Bond Xs YTM is expected to rise to 9% in one year (from 7% today). Compute the bonds current yield, (1-year expected) capital gains yield and (1-year expected) total yield (i.e., the 1-year expected holding period yield, HPY1-year). (9 marks)
(d) i) For Bond X, describe (in NO more than ONE line) the relationship between current yield, capital gains yield and holding period yield. (1 mark)
ii) If using the relationship specified in (d)(i) to estimate Bond Ys 1-year total yield, will the yield be over or under-estimated? Briefly explain (without ANY calculation support). (2 marks)
(e) Time flies (and now Bond X and Bond Y have just matured). Suppose you paid $900 to buy Bond Y six months ago (one period before its maturity). Calculate Bond Ys current yield, 6-month capital gains yield and YTM(APR) at the time of the purchase
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