Final answer:
To compare Bond X and Bond Z, we calculate the current yield and approximate yield to maturity for each. bond Z initially appears to be the better choice based on its higher current yield of 11.29% compared to Bond X's 10.42%. However considering the yield to maturity, which includes the full life of the bond may alter this decision.
Step-by-step explanation:
Harold Reese must choose between two bonds: Bond X and Bond Z. To compute the current yield on both bonds, we divide the annual interest by the market value of the bond. Therefore, for Bond X, the current yield is $86/$825 = 0.1042 or 10.42%, and for Bond Z, it is $96/$850 = 0.1129 or 11.29%.
Based on the current yield alone, Harold should select Bond Z because it has a higher current yield. However, current yield does not take into account the total life of the bond or the capital gains/losses due to the difference between purchase price and face value at maturity. For the approximate yield to maturity on Bond Z, we can use the approximation formula which involves the annual interest, the discount/premium on the face value, and the number of years to maturity. The formula is:Approximate yield to maturity = (Annual Interest + (Face Value - Purchase Price) / Number of years to maturity) / ((Face Value + Purchase Price) / 2)Given the bond's market value of $850, its par value of $1,000, annual interest of $96, and 7 years to maturity, we plug in the numbers to get:Approximate yield to maturity = ($96 + ($1,000 - $850) / 7) / (($1,000 + $850) / 2) = (Approximate value)
The exact yield to maturity would require more complex calculations often done using a financial calculator or specialized software. if the approximate yield to maturity for Bond Z is significantly higher than Bond X's yield to maturity of 11.11%, Harold may want to reconsider his choice, indicating a possible shift in his decision from part b to part c.