Tony Horn, CFA, is evaluating two bonds. The first bond, issued by Kanon Corp., pays a 7.5% annual coupon and is priced to yield 7.0%. The second bond, issued by Samuel Corp., pays a 7.0% annual coupon and is priced to yield 8.0%. Both bonds mature in ten years. If Horn can reinvest the annual coupon payments from either bond at 7.5%, what would his return be on each bond, assuming the bond was held to maturity?
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A. B. C.A
To determine the return on each bond, we need to consider the coupon payments and the reinvestment of those payments.
Let's start by calculating the annual coupon payment for each bond.
For the first bond issued by Kanon Corp., it has a 7.5% annual coupon. Since the bond pays a fixed coupon rate, the annual coupon payment will be 7.5% of the bond's face value.
For the second bond issued by Samuel Corp., it has a 7.0% annual coupon. Similar to the first bond, the annual coupon payment will be 7.0% of the bond's face value.
Both bonds mature in ten years, which means that after ten years, the principal amount will be returned to the bondholder.
Now, let's calculate the return on each bond, assuming the coupon payments are reinvested at a rate of 7.5%.
For the first bond issued by Kanon Corp., the annual coupon payment is reinvested at a rate of 7.5%. Since the coupon rate and the reinvestment rate are the same, the return on the reinvested coupon payments will be equal to the bond's yield of 7.0%. In other words, the return on the Kanon bond will be the same as its yield.
For the second bond issued by Samuel Corp., the annual coupon payment is reinvested at a rate of 7.5%, which is higher than the bond's yield of 8.0%. Reinvesting at a higher rate than the bond's yield will result in a higher return. Therefore, the return on the reinvested coupon payments for the Samuel bond will be greater than 8.0%.
Based on these calculations, the answer is C. The return on the Kanon bonds will be greater than 7.0%, and the return on the Samuel bonds will be greater than 8.0%.