Final answer:
The yield to maturity on Eyelops Owl Emporium's 14-year bonds is the total expected return if a bond is held until it matures. It includes interest payments and capital gains and is calculated using current selling price, face value, and the coupon payments. When interests rise, the price of existing bonds drops, and vice versa.
Step-by-step explanation:
The yield to maturity (YTM) is the total return expected on a bond if held until it matures. To calculate the YTM for Eyelops Owl Emporium's 14-year bonds, let's suppose these bonds are selling for less than their face value due to a rise in market interest rates. As a result, an investor buying the bond today would pay a discounted price, receive the fixed interest, also known as coupon payments, and eventually the face value of the bond upon maturity.
In this example, we have a bond with a face value of $1,000 and an annual coupon payment of 8%, which translates to $80. If the bond is currently selling for $964 and the investor holds the bond until maturity, they will receive $1,000 plus the last year's interest payment of $80. The return on investment would then be ($1080 - $964) / $964, which equals approximately 12%. This reflects the total return that includes both the interest payments and the gain from purchasing the bond at a discounted rate.
With changing interest rates, the selling price of bonds fluctuates. If rates go up, existing bonds with lower rates sell for less. Conversely, if the rates drop, bonds with higher rates become more valuable and sell above face value. Understanding the YTM is essential for investors to assess potential investments compared to the market rate.