Which is a better investment?:
1) A 5% coupon, paid semi-annually, 10-year bond priced @ $90.00 per hundred.
2) A 6% coupon, paid semi-annually, 10-year bond priced @ $97.25 per hundred.
Thanks for any help.
The only accurate way of comparing two similar investments, such as these two bonds, is to figure out their rate of return, which is called the "yield to maturity." There is no direct solution for the yield of a bond, but iteration and interpolation are used to find a rate that will equate the PV of the bond at maturity, which is almost always its par value, or $100.00, plus the PV of all the coupons to the purchase price of that bond.
My computer already has programmed in it the necessary software to calculate such yields almost instantaneously. All you do is enter the known variables and it will solve for the unknown, in this case, the yield to maturity:
1) A 5% coupon, paid semi-annually, 10-year bond priced @ $90.00 per hundred.
My computer calculates the yield to maturity as being: 6.36723930355% comp. semi-annually.
2) A 6% coupon, paid semi-annually, 10-year bond priced @ $97.25 per hundred.
My computer calculates the yield to maturity as being: 6.37614438663% comp. semi-annually.
As can be seen, there is virtually no difference between the two bonds, albeit the 2nd one has ever so slightly higher yield than the 1st. bond.
