A bond has a 1,000 par value, 10 years to maturity, a 7...

A bond has a $\$ 1,000$ par value, 10 years to maturity, a 7 percent annual coupon, and sells for $\$ 985$ a. What is its current yield? b. What is its yield to maturity (YTM)? c. Assume that the yield to maturity remains constant for the next 3 years. What will the price be 3 years from today?

A bond has a $\$ 1,000$ par value, 10 years to maturity, a 7 percent annual coupon, and sells for $\$ 985$
a. What is its current yield?
b. What is its yield to maturity (YTM)?
c. Assume that the yield to maturity remains constant for the next 3 years. What will the price be 3 years from today?

Key Concepts

Current Yield

Current yield is a measure of the bond’s annual coupon income relative to its current market price. It is calculated by dividing the annual coupon payment by the bond's current price, providing an indicator of the immediate return an investor might expect from holding the bond without considering any capital gains or losses.

Yield to Maturity (YTM)

Yield to Maturity is the internal rate of return of a bond, assuming it is held until maturity and that all coupon payments are reinvested at the same rate. It is found by equating the current price of the bond with the present value of all its future cash flows, including both the regular coupon payments and the lump-sum payment at maturity, thus representing the overall expected return.

Bond Pricing and Valuation

Bond pricing and valuation involve determining the present value of a bond's future cash flows by discounting them back to the present using an appropriate discount rate, often the yield to maturity. This concept is crucial for understanding how the market price of a bond reflects the collective expectations about future income and risk, and how bond prices adjust when interest rates change.

Time Value of Money

The time value of money is a fundamental financial principle that recognizes a dollar today is worth more than a dollar in the future due to its potential earning capacity. This principle underlies all bond valuation techniques, as it justifies the discounting of future cash flows to determine their present value, thereby influencing both current yield and yield to maturity calculations.

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