Question

Dave invests in a bond that yields 3. 50% annual effective for 10 years. The bond pays coupons at a rate of 3. 50%, payable semi-annually. It has a redemption value of $75. Mike invests in a 5 year bond. The bond pays coupons at a rate of 14. 00%, payable quarterly. It has a redemption value of $150. Mike paid twice the price for his bond compared to what Dave paid. Both bonds have a face amount of $100. Calculate the annual effective yield for Mike's bond

Answer 1

The annual effective yield for Mike's bond is 3.20%, which is less than Dave's 3.50%.

What is the annual effective yield of a bond?

The annual effective yield is the total return expected from a bond if the bond is held till maturity.

The annual effective yield rate is the rate at which all future expected cash flows are discounted to find out the current value or the price of the bond.

We can use the following Yield to Maturity formula to calculate the annual effective yield rate.

Yield to Maturity = [Annual Interest + {(FV-Price)/Maturity}] / [(FV+Price)/2]

Data and Calculations:

Mike's investment:

Quarterly Interest = $3.50 ($100 x 14% x 1/4)

Annual interest = $14 ($100 x 14%)

FV = Face Value of the Bond = $100

Price = Current Market Price of the Bond at Redemption = $150

Maturity = Time to Maturity = 5 years

= {$14 + ($100 - $150)/5} / {($100 + $150)/2}

= $14 + -10 / 250/2

= 4/125

= 3.2%

Thus, the annual effective yield for Mike's bond is 3.20%, which is less than Dave's 3.50%.

Learn more about the yield to maturity at brainly.com/question/26657407