Question

Last year Carson Industries issued a 10-year, 15% semiannual coupon bond at its par value of $1,000. Currently, the bond can be called in 6 years at a price of $1,075 and it sells for $1,280.

1. What are the bond's nominal yield to maturity and its nominal yield to call? Do not round intermediate calculations. Round your answers to two decimal places.

   YTM: %

   YTC: %

   Would an investor be more likely to earn the YTM or the YTC?

• What is the current yield? (Hint: Refer to Footnote 6 for the definition of the current yield and to Table 7.1) Round your answer to two decimal places.

  %

  Is this yield affected by whether the bond is likely to be called?

  1. If the bond is called, the capital gains yield will remain the same but the current yield will be different.
  2. If the bond is called, the current yield and the capital gains yield will both be different.
  3. If the bond is called, the current yield and the capital gains yield will remain the same but the coupon rate will be different.
  4. If the bond is called, the current yield will remain the same but the capital gains yield will be different.
  5. If the bond is called, the current yield and the capital gains yield will remain the same.
• What is the expected capital gains (or loss) yield for the coming year? Use amounts calculated in above requirements for calculation, if required. Negative value should be indicated by a minus sign. Round your answer to two decimal places.

  %

  Is this yield dependent on whether the bond is expected to be called?
  1. 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.
  2. If the bond is expected to be called, the appropriate expected total return is the YTM.
  3. If the bond is not expected to be called, the appropriate expected total return is the YTC.
  4. If the bond is expected to be called, the appropriate expected total return will not change.
  5. The expected capital gains (or loss) yield for the coming year depends on whether or not the bond is expected to be called.

Answer 1

YTM calculation: Coupon rate = 15%; par value = 1,000

semi-annual coupon payment = coupon rate*par value/2 = 15%*1,000/2 = 75

PV (current price) = 1,280; N (number of coupon payments remaining) = 9*2 = 18; PMT (or coupon payment) = 75, FV (or par value) = 1,000, CPT RATE.

Semi-annual YTM (or rate) = 5.09%

1). Annual YTM = 2*5.09% = 10.81%

YTC calculation: PV = 1,280; N (number of coupon payments to be made till the bond is called) = 6*2 = 12; PMT = 75, FV (or call price) = 1,075, CPT RATE.

Semi-annual YTC = 4.84%

2). Annual YTC = 2*4.84% = 9.69%

3). If interest rates remain the same, then the company is likely to call the bond as YTC is lower than YTM.

4). Current yield = annual coupon payment/current bond price

= (75*2)/1,280 = 11.72%

5). Is this yield affected by whether the bond is likely to be called? - Option (IV) - Even if the bond is called, current yield will remain the same but capital gains yield will change.

6). Expected capital gains yield = YTM - current yield = 10.18% - 11.72% = -1.54%

7). Is this yield dependent on whether the bond is expected to be called? - Option V - Yes, the expected capital gains yield depends on whether the bond is expected to be called or not. If it is not called then expected capital gains yield will be YTM - current yield. If it is expected to be called then expected capital gains yield will be YTC - current yield.