Question

Company Triple A semi-annual par value bonds currently sell for 105% of par. They have a 6.50% coupon rate and a 25-year maturity and are callable in 6 years at an 8% premium. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future.

- Under these conditions, what rate of return should an investor expect to earn if he or she purchases these bonds, the YTC or the YTM and why? Is this a discount or premium bond and why?

- What is the current yield of the bond?

- What happens to the YTM if the bond sells at 90% of par.? Compare your results to part a.

Answer #1

a) | Using an online calculator, the YTM = 6.10% and YTC = 6.59%. |

The investors can expect only the YTM of 6.10%, as that represents | |

the market interest rate. The firm will not make the call, as the YTC | |

is greater. | |

b) | Current yield on the bond = 65/1050 = 6.19% |

c) | The YTM will become = 7.39% and the YTC 9.83% |

The investors can expect only the YTM of 7.39%, as that represents | |

the market interest rate. The firm will not make the call, as the YTC | |

is greater. |

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