a company recently issued bonds with 8 years remaining to maturity, a coupon rate of 10 percent paid annually?

Question

A company recently issued bonds with 8 years remaining to maturity, a coupon rate of 10 percent paid annually, and a par value of £1,000. If the current market price is £814.45, what is the bond’s yield to maturity?

Answer 1

10% of par is £100 = so you get £100 per annum on a Bond that will cost you only £814.45 ..

This is a rate of 12.28% per year - only 'junk' bonds return this sort of return !

If the market price remains the same for the remaining 8 years (highly unlikely) AND the Bond is redeemed at par (plainly if it is selling at less than par there is a real significant risk that the Company will default on the Bond) then you will get 8x100 = £800 PLUS the £1000 par value = £1800 on a Bond that cost you £814.45 == 220 %.

This gives a (simplistic**) rate of approx 27.5% per year


** In the real world it is necessaary to calculate the Net Present Value (NPV).. £1000 in 8 years is NOT worth £1,000 today (you have to discount it by at least the rate of inflation) - and the same goes for £100 coupon paid next year, year after and so on (each should be discounted) .. however the market price of £814.45 is NOT discounted (since it is the actual value today).

Answer 2

10