honeycfa

When a bond's coupon rate is greater than its current yield, and its current yield is greater than its yield to maturity, the bond is a:

A) discount bond.

B) premium bond.

C) par value bond.

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For a premium bond, coupon rate > current yield > yield to maturity.
For a par bond, coupon rate = current yield = yield to maturity.
For a discount bond, coupon rate < current yield < yield to maturity.

honeycfa

Calculate the current yield and the yield-to-first call on a bond with the following characteristics:

• 5 years to maturity
• $1,000 face value
• 8.75% semi-annual coupon
• Priced to yield 9.25%
• Callable at $1,025 in two years

Current Yield

Yield-to-Call

A) 8.93% 5.51%

B) 9.83% 19.80%

C) 8.93% 11.02%

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To calculate the CY and YTC, we first need to calculate the present value of the bond: FV = 1,000; N = 5 × 2 = 10; PMT = (1000 × 0.0875) / 2 = 43.75; I/Y = (9.25 / 2) = 4.625; CPT → PV = -980.34 (negative sign because we entered the FV and payment as positive numbers). Then, CY = (Face value × Coupon) / PV of bond = (1,000 × 0.0875) / 980.34 = 8.93%.

And the YTC calculation is: FV = 1,025 (price at first call); N = (2 × 2) = 4; PMT = 43.75 (same as above); PV = –980.34 (negative sign because we entered the FV and payment as positive numbers); CPT → I/Y = 5.5117 (semi-annual rate, need to multiply by 2) = 11.02%.

honeycfa

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

honeycfa

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%.

honeycfa

LOS b, (Part 2): Explain the limitations and assumptions for traditional yield measures.

When computing the yield to maturity, the implicit reinvestment assumption is that the interest payments are reinvested at the:

A) prevailing yield to maturity at the time interest payments are received.

B) coupon rate.

C) yield to maturity at the time of the investment.

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The reinvestment assumption states that reinvestment must occur at the YTM in order for an investor to earn the YTM.  The assumption also states that payments are received in a prompt and timely fashion resulting in immediate reinvestment of those funds.  

 

honeycfa

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. 

honeycfa

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.

honeycfa

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.

honeycfa

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. 

honeycfa

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.