Consider the following data for bonds issued by Home Depot and Chevron. Both bonds have 9 years to maturity. The Home Depot bond has a coupon rate of 3.00% and a price of 100.231 (% of FV). The Chevron bond has a coupon rate of 2.50% and a price of 95.305 (% of FV). The bonds make semi-annual coupon payments.
a. Which bond is selling at a premium to par, and which bond is selling at a discount to par?
b. What is the relationship between coupon rate and yield to maturity for bonds selling at a discount to par? What is the relationship between coupon rate and yield to maturity for bonds selling at a premium to par? Given your answer, will the yield to maturity on the Home Depot bond be greater or less than 3.00%? Will the yield to maturity on the Chevron bond be greater or less than 2.50%?
c. Calculate the yield to maturity and current yield for each bond. For which bond is current yield a better estimate of yield to maturity?
d. An investor with a 3-year holding period purchases the Chevron bond. Coupons will be reinvested semiannually at a semiannual reinvestment rate of 1%. At the end of 3 years, the investor expects that the bond will sell at a yield to maturity of 2.8%. What is the investor’s forecasted compound yield (since this bond makes semi-annual coupon payments, you need to do semiannual compounding)?
e. Consider the three different yield calculations for the Chevron bond: current yield, yield to maturity, forecasted compound yield. What is one major shortcoming of each of these yield measures?