Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: alue (that is, B0 M) will always equal the coupon interest rate. When the bond value differs from par, the yield to maturity will differ from the coupon interest rate. Assuming that interest is paid annually, the yield to maturity on a bond can be found by solving Equation 6.7 for kd. In other words, the current value, the annual interest, the par value, and the years to maturity are known, and the required return must be found. The required return is the bond’s yield to maturity. The YTM can be found by trial and error or by use of a financial calculator. The calculator provides accurate YTM values with minimum effort. The Mills Company bond, which currently sells for $1,080, has a 10% coupon interest rate and $1,000 par value, pays interest annually, and has 10 years to maturity. Because B0 $1,080, I $100 (0.10 $1,000), M $1,000, and n 10 years, substituting into Equation 6.7a yields $1,080 $100 (PVIFAk ) d,10yrs $1,000 (PVIFk ) d,10yrs Our objective is to solve the equation for kd, the YTM. Trial and Error Because we know that a required return, kd, of 10% (which equals the bond’s 10% coupon interest rate) would result in a value of $1,000, the discount rate that would result in $1,080 must be less than 10%. (Remember that the lower the discount rate, the higher the present value, and the higher the discount rate, the lower the present value.) Trying 9%, we get $100 (PVIFA9%,10yrs) $1,000 (PVIF9%,10yrs) $100 (6.418) $1,000 (0.422) $641.80 $422.00 $1,063.80 Because the 9% rate is not quite low enough to bring the value up to $1,080, we next try 8% and get $100 (PVIFA8%,10yrs) $1,000 (PVIF8%,10yrs) $100 (6.710) $1,000 (0.463) $671.00 $463.00 $1,134.00 Because the value at the 8% rate is higher than $1,080 and the value at the 9% rate is lower than $1,080, the bond’s yield to maturity must be between 8% and CHAPTER 6 Input 10 9%. Because the $1,063.80 is closer to $1,080, the YTM to the nearest whole percent is 9%. (By using interpolation, we could eventually find the more precise YTM value to be 8.77%.)15 Function N 1080 PV 100 291 Interest Rates and Bond Valuation PMT 1000 Calculator Use [Note: Most calculators re...
View Full Document

This document was uploaded on 01/19/2014.

Ask a homework question - tutors are online