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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

A \(1,100-face-value bond has a 5% coupon rate, its current price is \)1,040, and it is expected to increase to $1070 next year. Calculate the current yield, the expected rate of capital gains, and the expected rate of return

What is the yield to maturity on a simple loan for \(1,500 that requires a repayment of \)15,000 in five years?

What is the formula used to calculate the yield to maturity on a 20-year coupon bond with a current yield of 12% and \(1,000 face value that sells for \)2,500
Consider a bond with a 6% annual coupon and a face value of $1,000. Complete the following table. What relationships do you observe between years to maturity, yield to maturity, and the current 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’t 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.)
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