Problem 1 For A Bond Selling For $921 With A Par Value Of $1

4aproblem 1for A Bond Selling For 921 With A Par Value Of 1000 And

Calculate the current yield of a bond selling for $921 with a par value of $1,000 and a coupon rate of 7.45 percent. First, determine the annual coupon payment by multiplying the par value by the coupon rate: $1,000 * 7.45% = $74.50. Next, divide the annual coupon payment by the bond's current market price to find the current yield: $74.50 / $921 ≈ 8.09%. Therefore, the current yield is approximately 8.09%.

Sample Paper For Above instruction

Understanding bonds and their yields is fundamental in finance, especially for investors seeking optimal returns and managing investment risks. The current yield, a simple measure of a bond’s annual income relative to its market price, provides insight into the income component of a bond investment. It is particularly useful when comparing bonds with similar credit qualities and maturities. In this paper, we explore the calculation and significance of current yield through practical examples, elucidating its computation, interpretation, and limitations.

In the first example, a bond with a face value of $1,000, a coupon rate of 7.45%, and trading at $921 demonstrates how to compute the current yield. The annual coupon payment is derived from the coupon rate multiplied by the face value: $1,000 * 7.45% = $74.50. The current yield then is calculated by dividing this coupon payment by the current market price: $74.50 / $921 ≈ 8.09%. This result indicates that, based on the current price, the bond provides approximately 8.09% income annually, which is higher than its coupon rate, suggesting a discount on the bond price due to market conditions or interest rate fluctuations.

The concept of current yield can be extended to other bond scenarios, such as a bond purchased at a premium, discount, or at par. It provides an easy-to-understand measure for investors to assess the income return relative to the cost of the bond, although it does not account for capital gains or losses that may occur if the bond is held to maturity. As such, it complements more comprehensive metrics like yield to maturity, which considers the total return assuming the bond is held until redemption.

Furthermore, the calculation of current yield is straightforward and relies on current market prices and known coupon payments, making it an accessible metric for both novice investors and seasoned financial analysts. However, reliance solely on current yield can be misleading in some cases, especially if the bond is expected to be called early or if significant changes in interest rates are anticipated. Consequently, investors often use current yield alongside other metrics, such as yield to maturity and duration, to make well-informed investment decisions.

In conclusion, the current yield is a vital, though simplistic, indicator of a bond’s annual income relative to its market price. It offers a snapshot of the income component but neglects potential capital gains or losses. Understanding how to accurately compute and interpret current yield empowers investors to compare bonds effectively, assess income streams, and make strategic investment choices aligned with their financial goals.

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