Question

Ultra-High Company Ltd is considering a bond issue. After significant deliberations, the

firm decides to issue zero-coupon bonds which matures in 5 years, with a face value of $1,000
and priced at $580. You want to know your potential yield before buying into the bonds. The
only way is to compute the yield to maturity (YTM). If other bonds of the same risk class are
offering 13%, would you invest in Ultra High’s bonds?

Answer 1

To determine whether it would be a good investment to buy Ultra-High Company Ltd's zero-coupon bonds, we need to compare the yield to maturity (YTM) of these bonds with the yield offered by other bonds of the same risk class, which is 13%.

The yield to maturity (YTM) is the total return anticipated on a bond if held until its maturity date. It takes into account the bond's current price, face value, time to maturity, and the interest payments (in this case, zero-coupon bonds have no interest payments).

To calculate the yield to maturity, we can use the following formula:

YTM = [(Face Value / Current Price) ^ (1 / Years to Maturity)] - 1

In this case, the face value is $1,000, and the current price is $580. The maturity period is 5 years.

YTM = [($1,000 / $580) ^ (1/5)] - 1

YTM ≈ 0.105 or 10.5% (rounded to the nearest tenth of a percent)

The yield to maturity of Ultra-High Company Ltd's bonds is approximately 10.5%.

Comparing this YTM of 10.5% with the yield offered by other bonds in the same risk class, which is 13%, it appears that the other bonds are offering a higher yield.

Based solely on the yield to maturity, it seems more advantageous to invest in the other bonds with a 13% yield rather than Ultra-High Company Ltd's bonds with a 10.5% yield.