Unlike the coupon interest rate, which is fixed, a bond’s
yield varies from day to day depending on market conditions. To be
most useful, it should give us an estimate of the rate of return an
investor would earn if that investor purchased the bond today and
held it for its remaining life. There are three different yield
calculations: Current yield, yield to maturity, and yield to
call.
A bond’s current yield is calculated as the annual interest
payment divided by the current price. Unlike the yield to maturity
or the yield to call, it does not represent the actual return that
investors should expect because it does not account for the capital
gain or loss that will be realized if the bond is held until it
matures or is called. This yield was popular before calculators and
computers came along because it was easy to calculate; however,
because it can be misleading, the yield to maturity and yield to
call are more relevant.
The yield to maturity (YTM) is the rate of return earned on a
bond if it is held to maturity. It is the interest rate that forces
the present value of the bond to equal the present values of the
interest payments received during the life of the bond and the
maturity value received at the bond’s maturity. Calculate YTM using
a financial calculator by entering the number of payment periods
until maturity for N, the price of the bond for PV, the interest
payments for PMT, and the maturity value for FV. Then solve for
I/YR = YTM. Remember, you need to make the appropriate adjustments
for a semiannual bond and realize that the calculated I/YR is on a
periodic basis so you will need to multiply the rate by 2 to obtain
the annual rate. In addition, you need to make sure that the signs
for PMT and FV are identical and that the opposite sign is used for
PV; otherwise, your answer will be incorrect.
The yield to call (YTC) is the rate of return earned on a bond
when it is called before its maturity date. The equation for
solving for the YTC is shown below:
Calculate YTC using a financial calculator by entering the
number of payment periods until call for N, the price of the bond
for PV, the interest payments for PMT, and the call price for FV.
Then you can solve for I/YR = YTC. Again, remember you need to make
the appropriate adjustments for a semiannual bond and realize that
the calculated I/YR is on a periodic basis so you will need to
multiply the rate by 2 to obtain the annual rate. In addition, you
need to make sure that the signs for PMT and FV are identical and
the opposite sign is used for PV; otherwise, your answer will be
incorrect.
A company is more likely to call its bonds if they are able to
replace their current high-coupon debt with less expensive
financing. A bond is more likely to be called if its price is
par—because this means that the going market interest rate is less
than its coupon rate.
Quantitative Problem: Ace Products has a bond issue
outstanding with 15 years remaining to maturity, a coupon rate of
8% with semiannual payments of $40, and a par value of $1,000. The
price of each bond in the issue is $1,196.00. The bond issue is
callable in 5 years at a call price of $1,080.
What is the bond's current yield? Round your answer to two
decimal places. Do not round intermediate calculations.
%
What is the bond's nominal annual yield to maturity (YTM)?
Round your answer to two decimal places. Do not round intermediate
calculations.
%
What is the bond's nominal annual yield to call (YTC)? Round
your answer to two decimal places. Do not round intermediate
calculations.
%
Assuming interest rates remain at current levels, will the
bond issue be called?
The firm call the bond.
A company is more likely to call its bonds if they are able to
replace their current high-coupon debt with less expensive
financing. A bond is more likely to be called if its price is
________ par—because this means that the going market interest rate
is less than its coupon rate.
Quantitative Problem: Ace Products has a bond issue
outstanding with 15 years remaining to maturity, a coupon rate of
8% with semiannual payments of $40, and a par value of $1,000. The
price of each bond in the issue is $1,196.00. The bond issue is
callable in 5 years at a call price of $1,080.
What is the bond's current yield? Round your answer to two
decimal places. Do not round intermediate calculations.
%
What is the bond's nominal annual yield to maturity (YTM)?
Round your answer to two decimal places. Do not round intermediate
calculations.
%
What is the bond's nominal annual yield to call (YTC)? Round
your answer to two decimal places. Do not round intermediate
calculations.
%
Assuming interest rates remain at current levels, will the
bond issue be called?
The firm call the bond.