Question

1.A bond has the following terms:

Principal amount $1,000

Annual Interest rate $75 starting 3 years have passed (that is in year 4)

Maturity 10 years

Callable @ $1,075 (that is face value + one year’s interest)

a) Why do you believe that the terms were constructed as specified?

b) What is the bond’s price if comparable debt yields 5 percent?

c)What is the bond’s current yield?

d) Even though interest rates have fallen, why may you not expect the bond to be called?

PLEASE SHOW WORK

Answer 1

Given Information

Principle Amount =$1000

Annual Interest Payment = $75 starting 3 years have passed

Maturity 10 years

a. The terms were constructed to save the interest expenses even through interest falls below 7.5% of coupon rate.

b. If the yield to maturity is 5%, the price is

P=75/ (1+.05) ^4+75/ (1+.05) ^5+…. +1075/ (1+.05) ^10

P=$988.80

c. Since coupon payment is 0;

current yield=annual cash inflow/market price=0

d. The interest might not have fallen as much as to compensate for the higher price that the call demands.

Hence it is not expecting to call the bond to be called off even through the interest has fallen

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