Question

Prepare a spreadsheet using Excel or a similar program in which you compute the items listed in parts a, b, and d. Be sure to compute the Yield-to-Maturity (YTM) and Yield-to-Call (YTC) for each of years 5, 6, 7, 8, and 9.

Kaufman Enterprises has bonds outstanding with a $1,000 face value and 10 years left until maturity. They have an 11% annual coupon payment, and their current price is $1,185. 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 call 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 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

YIELD TO MATURITY

Face value of bond

$1,000

Nper

Number of years to maturity

10

Pmt

Annual Coupon payment=1000*11%

$110

Pv

Current market Price

$1,185

Fv

Payment at maturity

$1,000

RATE

Yield to maturity

8.22%

(Using RATE function of excel with Nper=10,Pmt=110,Pv=-1185,Fv=1000)

Excel Command: RATE(10,110,-1185,1000)

b

YIELD TO CALL IN 5 YEARS

Nper

Number of years to Call

5

Pmt

Annual Coupon payment=1000*11%

$110

Pv

Current market Price

$1,185

Fv

Payment at Call

$1,090

RATE

Yield to CALL

7.91%

(Using RATE function of excel with Nper=5,Pmt=110,Pv=-1185,Fv=1090)

Excel Command: RATE(5,110,-1185,1090)

c

Investors will expect to earn Yield to call =7.91%

Since the market rate is lower, the company is likely to decide to call after 5 years and issue a new bond at marker rate

d

N

A

B

(Using RATE function of excel with Nper=N,Pmt=110,Pv=-1185,Fv=A)

Year to call

Payment at Call

Yield to call

6

$1,080

8.08%

Excel Command: RATE(6,110,-1185,1080)

7

$1,070

8.20%

Excel Command: RATE(7,110,-1185,1070)

8

$1,060

8.30%

Excel Command: RATE(8,110,-1185,1060)

9

$1,050

8.38%

Excel Command: RATE(9,110,-1185,1050)

Latest investors might expect the firm to Call the bonds=Year 5