Question

Yah Yah Corporations (YY) issues a bond that pays 10% semi-annual coupon, have a $1,000 face value, and mature in 10 years. If YY bonds are sold to yield 8%, what is the price of YY bond at the end of year 2. If YY issue the same bond (same coupon rate, face value and maturity) with ‘callable’ feature, would the price of YY bond be lower or higher? Explain. Callable bond: A bond that the issuer has the option to redeem before it reaches its stated maturity, and it allows the issuing company to pay off the debt early.

Answer 1

Part 1 – Calculation of Bond Price at the end of Year 2

We need to find out the Bond Price at the end of year 2 or at the beginning of Year 3..

Semi Annual Coupon Interest Rate = 10% / 2 = 5%

Semi Annual YTM = 8% / 2 = 4%

Face Value of Bond = $1,000

Semi Annual Coupon INterest = $1,000 * 5% = $50

Year		Cash Outflow	PVIF @ YTM 4%	Present Value
1	Semi Annual Coupon	$0	0.96154	$0
2	Semi Annual Coupon	$0	0.92456	$0
3	Semi Annual Coupon	$50	0.88900	$44.45
4	Semi Annual Coupon	$50	0.85480	$42.74
5	Semi Annual Coupon	$50	0.82193	$41.10
6	Semi Annual Coupon	$50	0.79031	$39.52
7	Semi Annual Coupon	$50	0.75992	$38.00
8	Semi Annual Coupon	$50	0.73069	$36.53
9	Semi Annual Coupon	$50	0.70259	$35.13
10	Semi Annual Coupon	$50	0.67556	$33.78
11	Semi Annual Coupon	$50	0.64958	$32.48
12	Semi Annual Coupon	$50	0.62460	$31.23
13	Semi Annual Coupon	$50	0.60057	$30.03
14	Semi Annual Coupon	$50	0.57748	$28.87
15	Semi Annual Coupon	$50	0.55526	$27.76
16	Semi Annual Coupon	$50	0.53391	$26.70
17	Semi Annual Coupon	$50	0.51337	$25.67
18	Semi Annual Coupon	$50	0.49363	$24.68
19	Semi Annual Coupon	$50	0.47464	$23.73
20	Semi Annual Coupon	$50	0.45639	$22.82
	Maturity Value	$1,000	0.45639	$456.39
				$1,041.60

Note Year 1 & 2 Value – Nil. No need to mentioned coupon interest since we need to find out bond price at end of year 2

The Bond Price at the end of Year 2 is $1,041.60

Part 2 - It is assumed that YTM also remain same.

In case of callable feature, the price of bond is not changed. It will remain same.