Question

For this Assignment, review the information presented in Problem 7-18 on page 255 of your course text. You will utilize the information in this week's readings and media to make a recommendation with regard to when to call a bond.

Kaufman Enterprises has bonds outstanding with a $1000 face value and 10 years left until maturity. they have an 11% annual coupon payment, and their current, and their current price is $1,175. The bonds may be called in 5 years at 109%of face value (call price=$1,090).

a. what is the yield to maturity?

b. What is the yield to call if they are called in 5 years?

c. which yield might investors expect to earn on these bonds? WHy?

d. The bond's indenture indicates that the call provision gives the firm the right to call the bonds at the end of each year beginning in year 5. In year 5, the bonds may be called at 109% of face value; but in each of the next 4 years , the percentage will decline by 1%. 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 forth. If the yeild 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

Years to maturity	10
Periods per year	1
Periods to maturity	10
Coupon rate	11%
Par value	1000
Periodic payment	110
Current price	1175
Call price	1090
Years until callable	5
Periods until callable	5

(a).

FV	1,000
PV	-1,175
nper	10
PMT	110
RATE (YTM)	8.35%

YTM = 8.35%

(b).

FV (Call price)	1,090
PV	-1,175
nper	5
PMT	110
RATE (YTC)	8.13%

YTC = 8.13%

(c). The bond is selling at a premium as the bond's coupon rate is greater than the YTM. This indicates that interest rates have declined since the bond was issued. Declining interest rates indicate that the issuer might prefer to call in the bond and issue a bond at the lower interest rate.So, investors should expect to earn the YTC of 8.13% on the bond.

(d). If the yield curve remains flat then it would make sense for the issuer to call in the bond, at the earliest and issue bonds at the lower interest rate. So, investors can expect the firm to call the bonds in 5 years.