Answer:
The answer is (A)
Explanation:
Whenever a bond is being traded and redeemable at par value, the Yield to Maturity (YTM) is always the same as bond coupon rate. This can be demonstrated below :
Yr CF [email protected]% PV [email protected] 5% PV
$ $ $
0 Market Price (1000) 1 (1000) 1 (1000)
1-10 Gross Interest 90 6.145* 553.05 7.722** 694.98
10 Redemption Value 1000 0.386 <u>386 </u> 0.614 <u> 614 </u>
(60.95) 308.98
*Using 10 years annuity discounting factor at 10%
** Using 10 years annuity discounting factor at 5%
YTM( Using IRR formula)= Lr+ (NPV+)÷ ( (NPV+) -(NPV-) ) *(Hr-Lr)
=5%+ (308.98) ÷ ( (308.98) -(-60.95) ) * (10-5)%
Hence, YTM =9.18%
≅ 9%
Option (A) This is true. A bond that is traded and redeemable at par value will not have any capital gain. Capital gains can only be realised when the redemption value is greater than the market price which implies that the bond holder is getting another return in addition to interest element.
In this case, the bond holder will only settle for returns accrued from higher coupon which is the only attractivess of this type of bond.
Option (B) .This is false. The bond YTM as calculated above is 9%
Option (C). This is false. The bond current yield is 9%.
Option (D). This is false. The bond current yield is 9% which is greater than capital gains that is currently zero.
