Question

Seven years ago the Sheraton Company issued 20-year bonds with a 12% annual coupon rate at their $1,000 par value. The bonds had an 5% call premium. Today (8 years since the bonds were issued), the bonds were called. Compute the realized rate of return for an investor who purchased the bonds when they were issued and held them until they were called. Would the investor be happy that the bonds were called early? Why or why not?

PLEASE SHOW WORK, EXPLANATION AND EQUATIONS

Answer 1

There is a typo in the question (First it says seven years ago the bonds were issued and later it says 8 years since the bonds were issued). Assuming the first to be correct i.e., seven years ago the bonds were issued

This cannot be solved by equations. Either one has to use Excel or financial calculator

Using financial calculator
N=7 (Bonds have been called seven years since their issue)
PMT=12%*1000 (Coupon rate*Par)
PV=-1000 (Bonds were issued at par)
FV=1000*(1+5%) (Bonds were called at 5% call premium)
CPT I/Y=12.4882%

Realised return is 12.4882%

The investors will not be happy as they would now have to invest at lower prevailing rates