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Problem: Land O'Toys issued a 6.5% coupon bond, which pays interest semi-annually. The bond will mature in 10 years and is currently priced at $1,037.19. The average yields to maturity for 10-year corporate bonds are reported in the following table by bond rating:
Bond Rating Yield % Bond Rating Yield %
AAA 5.4 BB 7.3
AA 5.7 B 8.2
A 6.0 CCC 9.2
BBB 6.5 C 12.0
D 14.5
Question: Compute the yield of maturity of the bonds before the purchase announcement and use it to determine the likely current bond rating. Compare to the YTM table illustrated below.
| |
Price |
Coupon Rate |
Current Yield |
Yield to Maturity |
Yield to Call (5 Yrs) |
Taxable Equivalent Yield (35% Tax Rate) |
| Treasury |
$1,000.00 |
5% |
5% |
5% |
|
5% |
|
|
|
| Treasury |
$1,100.00 |
5% |
4.55% |
3.79% |
|
3.79% |
|
|
|
| Treasury |
$900 |
5% |
5.56% |
6.37% |
|
6.37% |
|
|
|
| Corporate |
$1,000.00 |
6% |
6% |
6% |
6% |
6% |
|
|
|
| Corporate |
$1,110.00 |
6% |
5.41% |
4.61% |
4.59% |
4.61% |
|
|
|
| Corporate |
$900.00 |
6% |
6.67% |
7.44% |
9.52% |
7.44% |
|
|
|
| Muni |
$1,000.00 |
4% |
4% |
4% |
|
6.15% |
|
|
|
| Muni |
1,100.00 |
4% |
3.34% |
2.84% |
|
4.37% |
|
|
|
| Muni |
$900.00 |
4% |
4.44% |
5.30% |
|
8.16% |
|
|
|