Question

Kempton 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 $1,175. The bonds may be called in 5 years at 109% of face value (Call price = $1,090).

1. What is the yield to maturity? Do not round intermediate calculations. Round your answer to two decimal places.
     %
   
2. What is the yield to call if they are called in 5 years? Do not round intermediate calculations. Round your answer to two decimal places.
     %
   
3. Which yield might investors expect to earn on these bonds? Why?
   
   1. Investors would expect the bonds to be called and to earn the YTC because the YTC is greater than the YTM.
   2. Investors would not expect the bonds to be called and to earn the YTM because the YTM is greater than the YTC.
   3. Investors would not expect the bonds to be called and to earn the YTM because the YTM is less than the YTC.
   4. Investors would expect the bonds to be called and to earn the YTC because the YTC is less than the YTM.
   5. Investors would expect the bonds to be called and to earn the YTC because the YTM is less than the YTC.
   
   -Select-IIIIIIIVVItem 3
   
4. 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? Do not round intermediate calculations.

Answer 1

Answer a. FV of a bond is $ 1000, coupon Rate is 11% therefore PMT is 110 (11% 0f 1000) , No of years N is 10 and PV I.e current selling price is 1175

Hence YTM As per PMT function is 8.35%

Answer B yield to call if the bond is called at 5 years

FV = 1090 , PMT is $ 110, N is 5 , PV is 1175

Hence YTC is 8.13%

Answer C

Option b. Investor would not to expect bond to be called and to earn the YTM because the YTM is greater than YTC.

Answer D

Invester would like the bond to be called at 7th year because at 7th year the call price of bond at $ 1070 the YTC @ 8.37% of the bond surpasses the bond YTM of 8.35%

FV = 1070, PMT = 110, N is 7 , PV is 1175

Hence YTC is 8.37% which is > YTM of 8.35%