Economics_Ch16

# For example someone might ask what is the yield on

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Unformatted text preview: tock purchases occur in the secondary market. coupon rate The percentage of the face value that the bondholder receives each year until the bond matures. Section 2 Bonds 443 16 (428-459) EMC Chap 16 11/18/05 9:34 AM Page 444 people talk about the yield on the bond as being the same as the interest rate. For example, someone might ask “What is the yield on that bond?” when they are actually referring to the interest rate.) Now suppose that Joshua paid \$1,100 for the bond instead of \$950. In this case the yield would be \$50/\$1,100, or 4.54 percent. In other words, as the price paid for the bond rises, the yield declines. When are the coupon rate and yield the same? Obviously they are the same when the price paid for the bond equals the face value. For example, consider a bond with a face value of \$1,000 and a coupon rate of 5 percent. If the bond is purchased for \$1,000, then the yield (\$50/\$1,000), which is 5 percent, is equal to the coupon rate. Robin buys a bond with the face value of \$10,000 for \$9,000. The coupon rate on the bond is 4 percent. Because the coupon rate is 4 percent, Robin receives 4 percent of \$10,000 (the face value of the bond), or \$400, each year through the time when the bond matures. Because Robin bought the bond for a price lower than the face value, the bond’s yield will be higher than the coupon rate. To find the yield, we divide the annual coupon payment of \$400 by the price of the bond (\$9,000), giving us a yield of 4.4 percent. EXAMPLE: Two of the best known bond ratings are Standard &amp; Poor’s and Moody’s, both of which have informative Web sites. Bond Prices and Yields The price that a person pays for a bond depends on market conditions. The greater the demand for the bond relative to the supply, the higher the price. The price is important because it determines the yield that the bondholder receives on the bond. Let’s suppose that Sonya is currently the owner of a bond with a face value of \$1,000 and a coupon rate of 5 percent. She decides to sell this bond to Joshua for \$950. Now we know that the coupon payment on this bond will be 5...
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## This document was uploaded on 01/16/2014.

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