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To calculate gross redemption yield we use IRR formula. In this particular question there are 2 corporate bonds with par value of $1000 and coupon interest paid on an annual basis. 1st bond market price $1079.68,coupon rate 6% and redeemed at par in 5 yrs. Second one coupon rate of 4% and redeemed at par in 5 years and both have same gross redemption yield.
In the answer they have found npv for 5%(1043.27) and 4%(1089.01).i=4+[(1089.01-1079.68)/1089.01-1043.27)]
Could you please explain the above formula used to find out the yield.Thanks in advance.
Without knowing which book you are referring to and so without seeing how the answer has been printed, it seems that it is calculating the IRR in the normal way, using ‘guesses’ of 4% and 5%.
At 4%, it will be the PV that is 1089.01 (not the NPV) and that the NPV is therefore 1089.01 – 1079.68 = 9.33.
At 5%, the NPV is 1043.27 – 1079.68 = – 36.41.Therefore the IRR is 4% + (9.33 / (9.33 + 36.41)) x (5 – 4) = 4.203% (which is the same as the result of what you have typed).
Hello sir,
Thank you sir, this is kaplan book and it is ny misunderstanding that it is present value not net present value. Thank you for your time again.
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