Bond yields (LO16-2) An investor must choose between two bonds: Bond A pays $70 annual interest and has a market value of $925.

Bond yields (LO16-2) An investor must choose between two bonds: Bond A pays $70 annual interest and has a market value of $925. It has 10 years to maturity. Bond B pays $62 annual interest and has a market value of $910. It has two years to maturity. Assume the par value of the bonds is $1,000.

1.  Compute the current yield on both bonds.
2.  Which bond should she select based on your answer to part a?
3. She should pick bond A because it has the highest current yield.
4. A drawback of current yield is that it does not consider the total life of the bond. For example, the yield to maturity on Bond A is 8.12 percent. What is the yield to maturity on Bond B?

d.     Has your answer changed between parts b and c of this question in terms of which bond to select?

 Yes, Bond B’s yield to maturity is higher than A. This is because the $90 discount in Bond B will be recovered within two years whereas bond A has $75 as discount and will be recovered within 10 years.  

16-2.       Solution: #

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