Question

Company currently has a nine yrs bond that is callable in four yrs from today with a call premium of 1%. This bond annual coupon rate is 10% paid semi-annually and it is currently selling at $1,120 per share. What is the bond annual yield to call and the bond annual yield to maturity? Also, if general interest rate is expected to remains unchanged, based on comparison between yield to call and yield to maturity that you have calculated, do you think is best for this company to call this bond today and why or why not?

Answer 1

Calculate annual yield to maturity Using financial calculator, enter

FV=1000 (Par value)

PMT= 50 (Coupon=10%*1000/2)

N= 18 (9*2=18)

PV= -1120 (Price of the bond)

Solve for I/Y as 4.048351

YTM= 4.048351%*2 = 8.0967%

Now calculate YTC

Using financial calculator, enter

FV=1010 (Call value=1000*101%)

PMT= 50 (Coupon=10%*1000/2)

N= 8 (4*2=8)

PV= -1120 (Price of the bond)

Solve for I/Y as 3.374391

YTC= 3.374391%*2= 6.7488%

Here the YTM is greater than the YTC which means, the market interest rate is higher. The issuer will not call the bonds because new funds will have to be raised again without any benefit of lower interest. This means that the issuer will have to reissue the bonds at the same market interest rates. Rather there will be additional cost of reissue and so there is no benefit of calling the bonds.