Question

11. Last year Clark Company issued 10-year, 12% semiannual coupon bond at its pair value of $1,000. Currently, the bond can be called in 4 years at a price of $1,060 and it sells for $1,100. a. What are the bond’s nominal yield to maturity and its nominal yield to call? Would an investor be more likely to earn the YTM or the YTC? b. What is the current yield? Is this yield affected by whether the bond is likely to be called? (Hint: : Refer to footnote 7 for the definitions of the current yield and to table 7.1.) c. What is the expected capital gains (or loss) yield for the coming year? Is this yield dependent on whether the bond is expected to be called? *****PLEASE DO NOT COPY OTHER'S WORK AND NOT USE EXCEL, THANK YOU********

Answer 1

a.         Using a financial calculator, input the following to solve for YTM:

N = 18, PV = -1100, PMT = 60, FV = 1000, and solve for YTM = I/YR = 5.1355%.

However, this is a periodic rate.  The nominal YTM = 5.1355%(2) = 10.2709% » 10.27%.

For the YTC, input the following:

N = 8, PV = -1100, PMT = 60, FV = 1060, and solve for YTC = I/YR = 5.0748%.

However, this is a periodic rate.  The nominal YTC = 5.0748%(2) = 10.1495% » 10.15%.

So the bond is likely to be called, and investors are most likely to earn a 10.15% yield.

b.         The current yield = $120/$1,100 = 10.91%. The current yield will remain the same; however, if the bond is called the YTC reflects the total return (rather than the YTM) so the capital gains yield will be different.

c.         YTM   = Current yield + Capital gains (loss) yield

            10.27%            = 10.91% + Capital loss yield

            -0.64% = Capital loss yield.

This is the capital loss yield if the YTM is expected.

However, based on our calculations in Part a the total return expected would actually be the YTC = 10.15%. So, the expected capital loss yield = 10.15% – 10.91% = -0.76%.