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Chapter 4: Q. 7 (page 133)

When is the current yield a good approximation of the yield to maturity?

Short Answer

Expert verified

It is close to maturity near about 10 years.

Step by step solution

01

Step 1. Introduction

Current yield is an investment's annual income (hobby or dividends) divided through the contemporary fee of the security. This degree examines the contemporary fee of a bond, as opposed to searching at its face value.

02

Step 2. Explanation

When the bond price is very close to par or the maturity is over 10 years, the present yield will be a good approximation of the yield to maturity. This is because the present discounted values of cash flows further in the future are so little that the value of a long-term coupon bond is near to that of a perpetual with the same coupon rate.

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Most popular questions from this chapter

What is the price of a perpetuity that has a coupon of $70 per year and a yield to maturity of 1.5%? If the yield to maturity doubles, what will happen to the perpetuity鈥檚 price?

To help pay for college, you have just taken out a \(1,000 government loan that makes you pay \)126 per year for 25 years. However, you don鈥檛 have to start making these payments until you graduate from college two years from now. Why is the yield to maturity necessarily less than 12%? (This is the yield to maturity on a normal \(1,000 fixed-payment loan on which you pay \)126 per year for 25 years.)

Go to the St. Louis Federal Reserve FRED database, and find data on the interest rate on a four-year auto loan (TERMCBAUTO48NS). Assume that you borrow \(20,000 to purchase a new automobile and that you finance it with a four-year loan at the most recent interest rate given in the database. If you make one payment per year for four years, what will the yearly payment be? What is the total amount that will be paid out on the \)20,000 loan?

If mortgage rates rise from 5% to 10% but the expected rate of increase in housing prices rises from 2% to 9%, are people more or less likely to buy houses?

In this chapter, we discussed long-term bonds as if there were only one type, coupon bonds. In fact, investors can also purchase long-term discount bonds. A discount bond is sold at a low price, and the whole return comes in the form of a price appreciation. You can easily compute the current price of a discount bond by using the financial calculator at http://www .treasurydirect.gov/indiv/tools/tools_savingsbondcalc.htm.

To compute the values for savings bonds, read the instructions on the page and click on Get Started. Fill in the information (you do not need to fill in the Bond Serial Number field) and click on Calculate.
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