General Electric bonds have a par value of $1,000, sell for $1,070, mature in 6 years, and have a 7% coupon rate paid annually.
a. Calculate the current yield and yield to maturity for this bond.
b. Calculate the realized compound yield for an investor with a 4-year horizon and a reinvestment rate of 5% over the period. At the end of the 4 years, assume that the coupon bonds will sell at a YTM of 6%. (You need financial calculator or Excel to calculate yield to maturity)
c. Explain why the initial YTM is higher or lower than the realized compound yield. Would the initial YTM be higher or lower than the realized compound yield if the investor held the bond until maturity (and the reinvestment rate remained at 5%)? (Hint: Consider how the holding period length affects price risk and reinvestment risk.)