Question

In: Finance

A firm's bonds have a maturity of 10 years with a $1,000 face value, have an...

A firm's bonds have a maturity of 10 years with a $1,000 face value, have an 8% semiannual coupon, are callable in 5 years at $1,049, and currently sell at a price of $1,096.70.

  1. What is their nominal yield to maturity? Do not round intermediate calculations. Round your answer to two decimal places.

    %
  2. What is their nominal yield to call? Do not round intermediate calculations. Round your answer to two decimal places.

    %
  3. What return should investors expect to earn on these bonds?
    1. Investors would expect the bonds to be called and to earn the YTC because the YTM is less than the YTC.
    2. Investors would expect the bonds to be called and to earn the YTC because the YTC is greater than the YTM.
    3. Investors would not expect the bonds to be called and to earn the YTM because the YTM is greater than the YTC.
    4. Investors would not expect the bonds to be called and to earn the YTM because the YTM is less than the YTC.
    5. Investors would expect the bonds to be called and to earn the YTC because the YTC is less than the YTM.

Solutions

Expert Solution

a. YTM is the internal rate of return for all the cash flows including the price in you can use the excel and the IRR function with all the cash flows.

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
Year 0 Install 1 Install 2 Install 1 Install 2 Install 1 Install 2 Install 1 Install 2 Install 1 Install 2 Install 1 Install 2 Install 1 Install 2 Install 1 Install 2 Install 1 Install 2 Install 1 Install 2
$ (1,096.70) $     40.00 $        40.00 $     40.00 $        40.00 $     40.00 $     40.00 $     40.00 $     40.00 $     40.00 $        40.00 $    40.00 $    40.00 $    40.00 $    40.00 $    40.00 $    40.00 $    40.00 $    40.00 $    40.00 $ 1,040.00
3.33%

you can also type in the formula

use Excel to goal seek

b. For Next question(YTC) the yield is only calculated till year 5 and update the call value with the last installment

Year 1 Year 2 Year 3 Year 4 Year 5
Year 0 Install 1 Install 2 Install 1 Install 2 Install 1 Install 2 Install 1 Install 2 Install 1 Install 2
$ (1,096.70) $     40.00 $        40.00 $     40.00 $        40.00 $     40.00 $     40.00 $     40.00 $     40.00 $     40.00 $ 1,089.00
3.27%

c . Clearly YTM > YTC Therefore option III is right


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