10-4 Suppose that a bond has a yield to call (YTC) equal to 6.5 percent and...

10-4 Suppose that a bond has a yield to call (YTC) equal to 6.5 percent and a yield to maturity (YTM) equal to 6.3 percent. Explain the meanings of these numbers to bond investors.

Expert Solution

A yield to maturity refers to the return that the investor can expect if the investor holds the bond till it matures.It is also known as the redemption yield.The yield to maturity on a bond is used by an investor to determine whether the purchase of the bond is profitable or not.The investor can compare the yield to maturity with the return the investor anticipates and can thus determine whether investing in the bond is feasible or not.It can also be used to compare the returns different bonds offer.The Yield to maturity of a bond can be computed using the formula =Coupon +(Face Value-Price/n)/(face value+price/2). A yield to maturity of 6.5% implies that the cash flows(coupon or interest payments) from the bond will be reinvested at 6.5% till the specified maturity date.

Yield to call refers to the return an investor can receive if the investor holds the bond till the call date of the bond.The call date of the bond will precede the maturity date specified for the callable bond.Callable bonds refer to bonds that can be either redeemed by the investor or bought back by the issuer on a specified date and a specified price.The specific date is regarded as the call date and the specific price would be the call price.In the given case the yield to call of 6.3% refers to the return that the investors of the bond would get if they hold the bond till it's call date.

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