Question

Exxon Mobil issues two bonds with 20-year maturities. Both bonds are callable at

$1,050. The rst bond is issued at a deep discount with a coupon rate of 4% and a

price of $580 to yield 8.4%. The second bond is issued at par value with a coupon rate

of 8.75%.

(a) What is the yield to maturity of the par bond?

(b) In the same graph, draw the prices of each of the two bonds issued by Exxon

Mobil. Note: page 50 in lecture 10 shows how the price of a callable bond looks

like.

(c) If you expect rates to fall substantially in the next two years, which bond is more

likely to be called? Defend your answer.

(d) What is the capital gain on the 8.75% coupon bond if rates in the next two years

fall enough so that this bond is called?

(e) If you expect rates to fall substantially in the next two years, which bond would

you prefer to hold?

(f) Why is the yield to maturity of the par bond higher than the yield of the discount

bond? Defend your answer.

Answer 1

1. Since the second bond is issued at par value and assuming the bond is redeemable at par then the given coupon becomes the YTM I.e., 8.75

2. Since the second bond have higher rate of YTM than that of first bond, issuer loose more in case of second bond as the coupon rate is higher, where the market rates are substantially falling.

3. Given to that the bond is callable at 1050/- and assuming the par value to be 1000 at which investor bought, the capital? gain is 50.

4. The 8.75% coupon bond is more beneficial to hold when we expect the market rates to fall substantially. Because the value of such higher coupon bond in the market of lower interest rates goes high.

5. Since the coupon rate is very low on first bond and the value of discount offered on it is less than that of present value of second bond coupon, the first bond have lower yield