Question

YIELD TO CALL It is now January 1, 2016, and you are considering the purchase of an outstanding bond that was issued on January 1, 2014. It has a 9.5% annual coupon and had a 30-year original maturity. (It matures on December 31, 2043.) There is 5 years of call protection (until December 31, 2018), after which time it can be called at 109-that is, at 109% of par, or $1,090. Interest rates have declined since it was issued, and it is now selling at 116.575% of par, or $1,165.75. What is the yield to maturity? Round your answer to two decimal places. % What is the yield to call? Round your answer to two decimal places. % If you bought this bond, which return would you actually earn? Select the correct option. Investors would not expect the bonds to be called and to earn the YTM because the YTM is greater than the YTC. Investors would not expect the bonds to be called and to earn the YTM because the YTM is less than the YTC. Investors would expect the bonds to be called and to earn the YTC because the YTC is less than the YTM. Investors would expect the bonds to be called and to earn the YTC because the YTM is less than the YTC. Investors would expect the bonds to be called and to earn the YTC because the YTC is greater than the YTM. Suppose the bond had been selling at a discount rather than a premium. Would the yield to maturity have been the most likely return, or would the yield to call have been most likely? Investors would expect the bonds to be called and to earn the YTC because the YTM is less than the YTC. Investors would expect the bonds to be called and to earn the YTC because the YTC is greater than the YTM. Investors would expect the bonds to be called and to earn the YTC because the YTC is less than the YTM. Investors would not expect the bonds to be called and to earn the YTM because the YTM is greater than the YTC. Investors would not expect the bonds to be called and to earn the YTM because the YTM is less than the YTC.

Answer 1

YTM is calculated using the RATE function in Excel with these inputs:

nper = 28 (years remaining to maturity)

pmt = 9.5% * 1000 (annual coupon payment = coupon rate * face value)

pv = -1,165.75 (current price of bond)

fv = 1,000 (face value of the bond receivable on maturity)

RATE is calculated to be 8.00%. This is the YTM of the bond

YTM is calculated using the RATE function in Excel with these inputs:

nper = 3 (years remaining until call date)

pmt = 9.5% * 1000 (annual coupon payment = coupon rate * face value)

pv = -1,165.75 (current price of bond)

fv = 1,090 (amount receivable on calling the bond)

RATE is calculated to be 6.11%. This is the YTC of the bond

Investors would expect the bonds to be called and to earn the YTC because the YTC is less than the YTM. This is because interest rates have declined, and it is likely that the issuer of the bond will call these bonds and reissue new bonds at the lower interest rates. Hence the return earned on these bonds would be YTC and not YTM

Investors would not expect the bonds to be called and to earn the YTM because the YTM is greater than the YTC. If the bond was trading at a discount, it means that interest rates have risen. This makes it unlikely that the bond would be called. An investor would most likely earn the YTM in this case, and not YTC.