Question

Arnot international's bonds have a current market price of $1,200. The binds have an 11% annual coupon payment, a $1,000 face value, and 10 years left until maturity. The bonds may be called in 5 years at 109% of face value (call price = $1,090).

Which yield might investors expect to earn on these bonds?

The bond's indenture indicates that the call provision gives the firm the right to call them at the end of each year beginning in year 5. In year 5, they may be called at 109% of fave value, but in each of the next 4 years the call percentage will decline by 1 percent point. Thus, in year 6 they may be called at 108% of face value, in year 7 they may be called at 107% of face value, and so on. If the yield curve is horizontal and interest rates remain at their current level, when is the latest that investors might expect the firm to call the bonds?

Answer 1