Question

Pelzer Printing Inc. has bonds outstanding with 9 years left to maturity. The bonds have a 8% annual coupon rate and were issued 1 year ago at their par value of $1,000. However, due to changes in interest rates, the bond's market price has fallen to $917.30. The capital gains yield last year was

What is the yield to maturity? Do not round intermediate calculations. Round your answer to two decimal places.
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For the coming year, what is the expected current yield? (Hint: Refer to footnote 7 for the definition of the current yield and to Table 7.1.) Do not round intermediate calculations. Round your answer to two decimal places.


For the coming year, what is the expected capital gains yield? (Hint: Refer to footnote 7 for the definition of the current yield and to Table 7.1.) Do not round intermediate calculations. Round your answer to two decimal places.
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Will the actual realized yields be equal to the expected yields if interest rates change? If not, how will they differ?

As long as promised coupon payments are made, the current yield will change as a result of changing interest rates. However, changing rates will not cause the price to change and as a result, the realized return to investors should equal the YTM.

As rates change they will cause the end-of-year price to change and thus the realized capital gains yield to change. As a result, the realized return to investors will differ from the YTM.

As long as promised coupon payments are made, the current yield will change as a result of changing interest rates. However, changing rates will cause the price to change and as a result, the realized return to investors will differ from the YTM.

As long as promised coupon payments are made, the current yield will not change as a result of changing interest rates. However, changing rates will cause the price to change and as a result, the realized return to investors should equal the YTM.

As long as promised coupon payments are made, the current yield will change as a result of changing interest rates. However, changing rates will cause the price to change and as a result, the realized return to investors should equal the YTM.

2. Last year Carson Industries issued a 10-year, 13% semiannual coupon bond at its par value of $1,000. Currently, the bond can be called in 6 years at a price of $1,065 and it sells for $1,270.

What is the bond's nominal yield to maturity? Do not round intermediate calculations. Round your answer to two decimal places.
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What is the bond's nominal yield to call? Do not round intermediate calculations. Round your answer to two decimal places.
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Would an investor be more likely to earn the YTM or the YTC?
-Select-Since the YTC is above the YTM, the bond is likely to be called.Since the YTM is above the YTC, the bond is not likely to be called.Since the YTC is above the YTM, the bond is not likely to be called.Since the coupon rate on the bond has declined, the bond is not likely to be called.Since the YTM is above the YTC, the bond is likely to be called.Item 3

What is the current yield? (Hint: Refer to Footnote 7 for the definition of the current yield and to Table 7.1.) Round your answer to two decimal places.
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Is this yield affected by whether the bond is likely to be called?

If the bond is called, the current yield and the capital gains yield will both be different.

If the bond is called, the current yield and the capital gains yield will remain the same but the coupon rate will be different.

If the bond is called, the current yield will remain the same but the capital gains yield will be different.

If the bond is called, the current yield and the capital gains yield will remain the same.

If the bond is called, the capital gains yield will remain the same but the current yield will be different.

-Select-IIIIIIIVVItem 5

What is the expected capital gains (or loss) yield for the coming year? Use amounts calculated in above requirements for calcuation, if reqired. Round your answer to two decimal places. Enter a loss percentage, if any, with a minus sign.
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Is this yield dependent on whether the bond is expected to be called?

If the bond is expected to be called, the appropriate expected total return will not change.

The expected capital gains (or loss) yield for the coming year depends on whether or not the bond is expected to be called.

The expected capital gains (or loss) yield for the coming year does not depend on whether or not the bond is expected to be called.

If the bond is expected to be called, the appropriate expected total return is the YTM.

If the bond is not expected to be called, the appropriate expected total return is the YTC.

Answer 1

1) Capital gains yield

Capital gains yield is applicable if the buyer sells his bond now.

Capital gains yield = (Price at which sold -Price at which bought)/ price at which bought

= (917.30-1000)/1000 = -0.0827 = -8.27%

2) Yield to Maturity, YTM

Semi-annual yield y is the rate that satisfies the following bond equation:

P = 917.3 = (4%*1000) * PVIFA(4%, 18) + 1000*PVIF(4%,18) ---->expressed in semi-annual terms

At 5%, P = 883.1041, 4.5% = 939.20

Price increase of (939.2 - 883.1041 =56.0959 ) requires ytm decrease of 0.5%

Price increase of (917.3 - 883.1041 = 34.1959) would require decrease of 0.5%/56.0959*34.1959 = 0.3048%

So, ytm = 5% - 0.3048% = 4.6952%

Hence, Yield to maturity on semi-annual basis = 4.70%

Bond equivalent yield on annual basis = 2 * 4.70% = 9.4%

Effective annual bond yield = 9.62%

3) Current Yield

Current Yield = Coupon / Purchase price = 8%*1000 / 917.3 = 0.087212 = 8.72%

4) Expected Capital gains yield

Assuming that the bond's yield to maturity will remain at 4.69% at the end of the year,

Price at end of the year = 40 * PVIFA(4.69%, 16) + 1000*PVIF(4.69%,16) = 923.54

So, capital gains yield if the buyer holds on to the bond and sells it at the end of the year at constant semi-annual ytm of 4.69% will be

CG = (923.54 - 917.3) / (917.3) = 6.80%

5) As long as promised coupon payments are made, the current yield will change as a result of changing interest rates. However, changing rates will cause the price to change and as a result, the realized return to investors will differ from the YTM.

Question 2

1) Semi-annual coupon = 6.5% Semi-annual periods to maturity = 2 * 9 = 18

1270 = 65 * PVIFA(y, 18) + 1000*PVIF(y,18)

For 4%, P = 1316.48 and for 4.5% = 1243.20

By interpolation, we can show that at 4.31%, Price =1270.38

Hence, semi-annual YTM = 4.31%

Bond equivealnt annual yield = 8.62%

2) Bond's yield to call

Yield to call of the bond is calculated using time to maturity as time to call and redemption value at call price.

1270 = 65 * PVIFA(yc, 12) + PVIF(yc,12)*1065

1270 = 65 * (1+yc)^12-1)/(yc*(1+yc)^12) + 1065 / (1+yc)^12

By expressing in terms of above formula and using goal seek feature of excel, we can directly calculate the ytm.

Value of yc that satisifes the above equation is yc = 4.05%

Annual bond equivalent yield to call = 8.10%

3) Answer: Since the YTM is above the YTC, the bond is likely to be called

The interest rates have come down as indicated by bond selling at premium. So, it is beneficial for the firm to refinance the bond with lower interest rate. Since bond has call option and the yield to call is lower, it is likely that it will redeem the bond at call price if the interest rates remain at same lower level.

4) Current yield

Current yield = 130 / 1270 = 0.102362 = 10.24%

5) Question and choices not related and clear (also refer end note at the end of last answer for conceptual clarity)

The yield of a callable bond will be more than a straight bond. Hence, price of a callable bond will be lower leading to lower current yield. With reference to question and choices, the question however compares between current and capital gains yield which are not comparable and also since capital gains yield in this case will be negative as the current price of the stock is 1270 while redemption price when called will be 1065. Overall yield for a buyer who purchases now at 1270 and redeems it at 1065 after 6 years will be 4.05% semi-annual.

(6) Expected CG yield for coming year

Assuming ytm remains at 4.31%,

Price at the end of year = 65*((1+4.31%)^16-1)/(4.31%*(1+4.31%)^16)+1000/(1+4.31%)^16 = 1249.45

CG yield = (1249.45 - 1270)/1270 = -0.016183 = - 1.62%

(7) Answer: The expected capital gains (or loss) yield for the coming year depends on whether or not the bond is expected to be called.

Whether the bond will be called depends on expected interest rates movement and possible rate at 6th year during which time only bond can be called. If the interest rates keep going down, the bond prices will keep increasing and hence at the end of the year the price of the bond will be higher, Hence, capital gains yield will depend on the interet rates.

(Note: The yield of a callable bond will be more than yield of a bond without call option. This is because the callable bond is equivalent to a bond plus a call option granted by bondholders.

Price of a callable bond = Price of straight bond - price of call option

Hence, the price of a callable bond will be less compared to straight bond to the extent of value of that call option. Hence, yield to maturity will be greater. With regard to how ytm changes for a callable bond, it depends on the yield curve scenario for both the remaining term to maturity and term to call.

The price of the call option will increase if the interest rates go down making refinancing of the bond beneficial for the corporate. As the price of call option increases, bond price comes down compared to straight bond making the ytm of the callable bond higher. Thus, as the bond becomes callable, ytm increases. this leads to lower price and hence higher current yield and greater capital gains yield)