Posted: July 12th, 2016
You are advising a client who is evaluating two potential bond investments. Bond A is a zero coupon bond with a face value of $1000 maturing in 8 years. Its current market price is $676.84. Bond B has an annual coupon rate of 6% and makes semiannual interest payments. It also has a face value of $1000 and matures in 8 years. Bond B has a market value of $939.53. Your client expects to hold one of these bonds for 5 years.
a. The yield to maturity for Bond A is 5%. Compute the yield to maturity for Bond B. What are you implicitly assuming when you compute yield to maturity?
c. After 5 years, you expect the price for Bond A to be $813.50 and Bond B to be $922.63. Compute the realized (Or horizon) yield for each bond over the 5 year holding period. Coupons for Bond B are assumed reinvested at an annual rate of 2%. Based on your analysis, which bond is the better option for your client?
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