One bond has a coupon rate of 6.8%, another a coupon rate of 8.4%. Both bonds pay interest annually, have 8-year maturities, and sell at a yield to maturity of 7.0%.

One bond has a coupon rate of 6.8%, another a coupon rate of 8.4%. Both bonds pay interest annually, have 8-year maturities, and sell at a yield to maturity of 7.0%.

a. If their yields to maturity next year are still 7.0%, what is the rate of return on each bond? (Do not round intermediate calculations. Enter your answers as a percent rounded to 1 decimal place.)





b. Does the higher-coupon bond give a higher rate of return over this period?

Answer
No

Some values below may show as rounded for display purposes, though unrounded numbers should be used for actual calculations.

a.
Bond 1:
Year 1:  PV=$68×[10.070−180.070(1.070)]+$1,00081.070=$988.06


Year 2:  PV=$68×[10.070−170.070(1.070)]+$1,00071.070=$989.22


Using a financial calculator:
Year 1: PMT = 68, FV = 1,000, i = 7.0%, n = 8; compute PV₀ = $988.06
Year 2: PMT = 68, FV = 1,000, i = 7.0%, n = 7; compute PV₁ = $989.22
 

Rate of return =	$68 + ($989.22 − 988.06)	= 0.070, or 7.0%
	$988.06

 
Bond 2:
Year 1: PV=  $84 ×[10.070 − 10.070(1.070)8] + $1,0001.0708 = $1,083.60


Year 2: PV=  $84 ×[10.070 − 10.070(1.070)7] + $ 1,0001.0707 = $ 1,075.45


Using a financial calculator:
Year 1: PMT = 84, FV = 1,000, i = 7.0%, n = 8; compute PV₀ = $1,083.60
Year 2: PMT = 84, FV = 1,000, i = 7.0%, n = 7; compute PV₁ = $1,075.45

Rate of return =	$84 + ($1,075.45 − 1,083.60)	= 0.070, or 7.0%
	$1,083.60

b.
Both bonds provide the same rate of return.
Thank you!