1. Remington, Inc. issued a new series of bonds on April 1, 2020. These non-callable bonds were sold at par, have a 9.25 percent coupon and mature in 25
years on March 31, 2045. Coupon payments are made on October 1 and April 1. Assume that you purchased an outstanding Remington bond on March 17,
2023. At the time you purchased the bond, the current yield was 10.57 percent.
a. Do you expect the current yield to be a good approximation of the bond’s yield to maturity? Explain why.
b. Assume the bond’s yield to maturity is 10.74 percent and the bond is based on a 30/360 day-count method. Compute the bond’s clean price.
c. What will be the actual price you pay for the bond? (i.e., the invoice/dirty price)
Sample Solution
a. No, the current yield is not a good approximation of the bond’s yield to maturity. Current yield does not take into account any capital gains or losses that may occur during the life of the bond as it only considers coupon payments and face value at time of purchase. Yield to maturity takes into account all cash flows from both coupons and capital gains/losses that may result from buying and selling the bond before it matures.
Sample Solution
a. No, the current yield is not a good approximation of the bond’s yield to maturity. Current yield does not take into account any capital gains or losses that may occur during the life of the bond as it only considers coupon payments and face value at time of purchase. Yield to maturity takes into account all cash flows from both coupons and capital gains/losses that may result from buying and selling the bond before it matures.
