Question

Problem 7-12
Yield to call

It is now January 1, 2011, and you are considering the purchase of an outstanding bond that was issued on January 1, 2009. It has a 8.5% annual coupon and had a 30-year original maturity. (It matures on December 31, 2038.) There is 5 years of call protection (until December 31, 2013), after which time it can be called at 109-that is, at 109% of par, or $1,090. Interest rates have declined since it was issued; and it is now selling at 116.575% of par, or $1,165.75.

a.What is the yield to maturity? Round your answer to two decimal places.
%

b.What is the yield to call? Round your answer to two decimal places.
%

c.If you bought this bond, which return would you actually earn? Explain your reasoning.(select multiple choice answer)

-Investors would expect the bonds to be called and to earn the YTC because the YTC is greater than the YTM.

-Investors would not expect the bonds to be called and to earn the YTM because the YTM is greater than the YTC.

-Investors would not expect the bonds to be called and to earn the YTM because the YTM is less than the YTC.

-Investors would expect the bonds to be called and to earn the YTC because the YTC is less than the YTM.

-Investors would expect the bonds to be called and to earn the YTC because the YTM is less than the YTC.

d.Suppose the bond had been selling at a discount rather than a premium. Would the yield to maturity have been the most likely return, or would the yield to call have been most likely? (select multiple choice answer)

-Investors would not expect the bonds to be called and to earn the YTM because the YTM is less than the YTC.

-Investors would expect the bonds to be called and to earn the YTC because the YTM is less than the YTC.

-Investors would expect the bonds to be called and to earn the YTC because the YTC is greater than the YTM.

-Investors would expect the bonds to be called and to earn the YTC because the YTC is less than the YTM.

-Investors would not expect the bonds to be called and to earn the YTM because the YTM is greater than the YTC.

Answer 1

a	Yield to maturity
	FV	1000
	PV	1165.75
	PMT	85	(1000 x 8.5%)
	NPER	28
	YTM	7.12%
		=RATE(28,85,-1165.75,1000)
b	Yield to call
	FV	1090	Call price
	PV	1165.75
	PMT	85	(1000 x 8.5%)
	NPER	3
	YTM	5.23%
		=RATE(3,85,-1165.75,1090)
c	D Investors would expect the bonds to be called and to earn the YTC because the YTC is less than the YTM.
d	A Investors would not expect the bonds to be called and to earn the YTM because the YTM is less than the YTC.