Question

Absalom Motors' 15% coupon rate, semiannual payment, $1,000 par value bonds that mature in 25 years are callable 4 years from now at a price of $750. The bonds sell at a price of $1,300, and the yield curve is flat. Assuming that interest rates in the economy are expected to remain at their current level, what is the best estimate of the nominal interest rate on new bonds? Do not round intermediate calculations. Round your answer to two decimal places.

Answer #1

Hello

Particulars | Computation | |

Number of periods to call | 50 | |

Maturity Price | 1000 | |

Current Price | 1300 | |

Coupon Payment | 75 | =1000*15%/2 |

Yield to Call | 5.68% | =RATE(8,75,-1300,750,0) |

Annual YTM | 11.36% | =5.68%*2 |

Particulars | Computation | |

Number of periods to call | 8 | |

Call Price | 750 | |

Current Price | 1300 | |

Coupon Payment | 75 | =1000*15%/2 |

Yield to Call | 0.59% | =RATE(8,75,-1300,750,0) |

Annual YTC |
1.18% |
=0.59%*2 |

Since, YTC will be lower than YTM and interest rate would be flat in future, so bond will be called after 4 year.

So coupon rate of new bond is equal to yield to call of bond that is 1.18%.

I hope this clears your query.

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