Reading 65: Yield Measures, Spot Rates, and Forward Rates LO 2010, currently, following, interpret

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LOS b, (Part 1): Compute and interpret the traditional yield measures for fixed-rate bonds.

PG&E has a bond outstanding with a 7% semiannual coupon that is currently priced at $779.25. The bond has remaining maturity of 10 years but has a first put date in 4 years at the par value of $1,000. Which of the following is closest to the yield to first put on the bond?

A) 14.46%.

B) 7.73%.

C) 14.92%.

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To compute yield to first put, enter: FV = $1,000; N = 2 × 4 = 8; PMT = $35; PV = -$779.25; CPT → I/Y = 7.23%, annualized as (7.23)(2) = 14.46%.

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A bond will sell at a discount when the coupon rate is:

A) less than the current yield and the current yield is less than the yield to maturity.

B) greater than the current yield and the current yield is greater than the yield to maturity.

C) less than the current yield and the current yield is greater than the yield to maturity.

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When a bond sells at a discount the nominal yield, coupon yield divided by the face value, will be less than current yield and current yield will be less than YTM. 

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Which of the following statements concerning the yield-to-maturity on a bond is CORRECT? Yield to maturity (YTM) is:

A) based on the assumption that any payments received are reinvested at the current yield.

B) the discount rate that will set the present value of the payments equal to the bond price.

C) below the current yield minus capital gain when the bond sells at a discount, and above the current yield plus capital loss when the bond sells at a premium.

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Reinvestments occur at the YTM. The YTM will find the present value of a future value and associated payments.

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In which of the following cases is the bond selling at a discount? The coupon rate is:

A) greater than current yield and current yield is greater than yield-to-maturity.

B) smaller than current yield and current yield is smaller than yield-to-maturity.

C) smaller than current yield and current yield is greater than yield-to-maturity.

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When a bond is selling at a discount the nominal yield, coupon payment divided by face value, will be less than current yield and current yield will be less than YTM. 

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In which of the following conditions is the bond selling at a premium? The coupon rate:

A) current rate and yield-to-maturity are all the same.

B) is less than current yield, which is less than yield-to-maturity.

C) is greater than current yield, which is greater than yield-to-maturity.

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When a bond is selling at a premium the nominal yield, coupon payment divided by face value, will be greater than current yield and current yield will be greater than YTM.

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The yield to maturity (YTM) is:

A) the discount rate that will set the present value of the payments equal to the bond price.

B) neither of these answers are correct.

C) below the coupon rate when the bond sells at a discount, and about the coupon rate when the bond sells at a premium.

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The YTM is a measure that will take into account present value, future value, periodic payments, and periods until maturity to find the rate of return that is being earned.  If the YTM is given, the result will be finding the present value of the future value and periodic cash flows. 

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Which of the following is a limitation of the cash flow yield measure? The cash flow yield measure:

A) assumes that interest rates do not change over the life of the security.

B) assumes a flat yield curve.

C) assumes that the projected cash flows are reinvested at the cash flow yield.

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Cash flow yield has two major deficiencies: (i) it is implicitly assumed that the cash flows will be reinvested at the cash flow yield prevailing when the MBS or ABS is priced, and (ii) it is assumed that the MBS or ABS will be held until maturity.

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Regarding the computation of the cash flow yield for an agency security, which of the following is the best reason why the assumption that the projected cash flows are actually realized is very restrictive?

A) Interest rate risk.

B) Prepayments.

C) Default risk.

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Prepayments instill uncertainty into the assumed cash flows used to compute cash flow yield.

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A $1,000 par value, 10%, semiannual, 20-year debenture bond is currently selling for $1,100. What is this bond's current yield and will the current yield be higher or lower than the yield to maturity?

       Current Yield    Current Yield vs. YTM

A) 8.9%    lower

B) 9.1%    higher

C) 8.9%    higher

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Current yield = annual coupon payment/price of the bond

CY = 100/1,100 = 0.0909

The current yield will be between the coupon rate and the yield to maturity. The bond is selling at a premium, so the YTM must be less than the coupon rate, and therefore the current yield is greater than the YTM.

The YTM is calculated as: FV = 1,000; PV = -1,100; N = 40; PMT = 50; CPT → I = 4.46 × 2 = 8.92

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An investor is interested in buying a 4-year, $1,000 face value bond with a 7% coupon and semi-annual payments. The bond is currently priced at $875.60. The first put price is $950 in 2 years. The yield to put is closest to:

A) 8.7%.

B) 10.4%.

C) 11.9%.

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N = 2 × 2 = 4; PV = -875.60; PMT = 70/2 = 35; FV = 950; CPT → I/Y = 5.94 × 2 = 11.88%.