Question

Question 1: Six years ago the Templeton Company issued 30-year bonds with a 15% annual coupon rate at their $1,000 par value. The bonds had a 9% call premium, with 5 years of call protection. Today Templeton called the bonds. Compute the realized rate of return for an investor who purchased the bonds when they were issued and held them until they were called. Round your answer to two decimal places.

Why should or should not the investor be happy that Templeton called them?

A. Investors should be happy. Since the bonds have been called, interest rates must have risen sufficiently such that the YTC is greater than the YTM. If investors wish to reinvest their interest receipts, they can now do so at higher interest rates.

B. Investors should be happy. Since the bonds have been called, investors will receive a call premium and can declare a capital gain on their tax returns.

C. Investors should be happy. Since the bonds have been called, investors will no longer need to consider reinvestment rate risk.

D.Investors should not be happy. Since the bonds have been called, interest rates must have fallen sufficiently such that the YTC is less than the YTM. If investors wish to reinvest their interest receipts, they must do so at lower interest rates.

Answer 1

Solution:
Given:
Term of Bond i.e NPER	6
Coupon Rate	15%
Coupon amount i.e PMT	$150
(Face value * Coupon rate)	(1000*15%)
Purchase value i.e PV	$1000
Call price after 6 Years i.e FV	$1090
(Face value + (Face value*call Premium)	($1000+($1000*9%)
To calculate the Realised rate of return we will use the RATE Function in excel
to find the realised rate of return over 6 years period
RATE(6,$150,-$1000,$1090,0)
16.00245%
Realised rate of Return is 16.00%
D.   Investors should not be happy. Since the bonds have been called, interest rates
must have fallen sufficiently such that the YTC is less than the YTM. If investors wish
to reinvest their interest receipts, they must do so at lower interest rates.
Explanation:
YTC i.e Coupon rate	15%
YTM	16%
As the YTC is less than YTM on bond investor will not be happy that they bonds are called ,this
indicates that the interest rates have fallen sufficiently than in such a way that YTC is less than YTM (15% < 16%)