Question #58588

An investor must choose between two bonds: Bond X pays $95 annual interest and has a market value of $900. It has 10 years to maturity. Bond Z pays $95 annual interest and has a market value of $920. It has two years to maturity. a. Compute the current yield on both bonds. b. Which bond should he select based on your answer to part a? c. A drawback of current yield is that it does not consider the total life of the bond. For example, the approximate yield to maturity on Bond X is 11.21 percent. What is the approximate yield to maturity on Bond Z? d. Has your answer changed between parts b and c of this question in terms of which bond to select?

Expert's answer

Bond X pays $95 annual interest, has a market value of $900 and has 10 years to maturity. Bond Z pays $95 annual interest, has a market value of $920 and has two years to maturity.

a. The current yield on bond X is 95/900*100% = 10.56%

The current yield on bond Z is 95/920*100% = 10.33%

b. According to the answer to part a bond X should be selected.

c. If the approximate yield to maturity on Bond X is 11.21 percent, then the approximate yield to maturity on Bond Z will be lower.

d. So, we should select bond X according to the longer period to maturity.

a. The current yield on bond X is 95/900*100% = 10.56%

The current yield on bond Z is 95/920*100% = 10.33%

b. According to the answer to part a bond X should be selected.

c. If the approximate yield to maturity on Bond X is 11.21 percent, then the approximate yield to maturity on Bond Z will be lower.

d. So, we should select bond X according to the longer period to maturity.

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