Question

WKRP Incorporated issues bonds which currently sell for $950.00. It pays a 2.1% annual coupon and has 14 years to maturity. The bonds can be called in 5 years at $1,025. What is the bond’s Yield to Maturity? What is the bond’s Yield to Call? If interest rates are expected to fall, is the bond more or less likely to be called? Explain.

Answer 1

Number of Years to Maturity = 14

Coupon Payment PMT = 2.1%*1000 = $21

Par Value= $1000

Market Price = $950

Yield to Maturity = (PMT + (Par Value - Market Price)/Number of Years to Maturity) / ((Par Value + Market Price)/2)

= (21 + (1000 - 950)/14) / ((1000 + 950)/2) = 0.0252 or 2.52%

Callable Price = $1025

Number of Years to call = 5

Yield to Call = (PMT + (Par Value - Callable Price)/Number of Years to Maturity) / ((Par Value + Callable Price)/2)

= (21 + (1000 - 1025)/5) / ((1000 + 1025)/2) = 0.0158 or 1.58%

If the interest rates reduce, the company is more likely to call the bonds to refinance the debt at a lower rate of interest. So the company calls the bonds and reissues them at a lower interest rate.