Question

Arnot International's bonds have a current market price of $1,250. The bonds have an 12% 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). What is the yield to maturity? Round your answer to two decimal places. ________ % What is the yield to call if they are called in 5 years? Round your answer to two decimal places. ________ % Which yield might investors expect to earn on these bonds, and why? _________________ I. Investors would expect the bonds to be called and to earn the YTC because the YTC is less than the YTM. II. Investors would expect the bonds to be called and to earn the YTC because the YTM is less than the YTC. III. Investors would not expect the bonds to be called and to earn the YTM because the YTM is greater than the YTC. IV. Investors would not expect the bonds to be called and to earn the YTM because the YTM is less than the YTC. 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 face value, but in each of the next 4 years the call percentage will decline by 1 percentage 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

a) Given , PV= -1250, PMT=120, N=10, FV=1000 .

Thus, to find yield to maturity, Put PV=-1250, FV=1000, PMT= 120, N=5 .Put all these values in financial calculator and press CPT and I/Y . Thus, I/Y= 8.2347% this is yield to maturity.

b) To find yield to call, it is stated that the bond may be called after 5 years at 1090.Thus, at that point of time i.e. after 5 years, put PV=-1090, FV=1000, PMT= 120, N=5 .Put all these values in financial calculator and press CPT and I/Y . Thus, I/Y= 9.65% this is yield to call.

c) Answer is 2,the investor would expect the bond to be called because YTC is greater than YTM.

D) If bond is called in 5th year, then put PV=-1090, FV=1000, PMT= 120, N=5 .Put all these values in financial calculator and press CPT and I/Y . Thus, I/Y= 9.65% this is yield to call.

If bond is called in 6th year, then put PV=-1080, FV=1000, PMT= 120, N=4 .Put all these values in financial calculator and press CPT and I/Y . Thus, I/Y= 9.50% this is yield to call.

If bond is called in 7th year, then put PV=-1070, FV=1000, PMT= 120, N=3 .Put all these values in financial calculator and press CPT and I/Y . Thus, I/Y= 9.22% this is yield to call.

If bond is called in 8th year, then put PV=-1060, FV=1000, PMT= 120, N=2.Put all these values in financial calculator and press CPT and I/Y . Thus, I/Y= 8.61% this is yield to call.

If bond is called in 9th year, then put PV=-1050, FV=1000, PMT= 120, N=1 .Put all these values in financial calculator and press CPT and I/Y . Thus, I/Y= 6.67% this is yield to call.

Since yield to call at 5th year is the highest, investors will expect the firm to call the bonds in 5th year.