Question

Nine years ago the Templeton Company issued 17-year bonds with an 12% annual coupon rate at their $1,000 par value. The bonds had an 8% call premium, with 5 years of call protection. Today Templeton called the bonds.

A. Compute the realized rate of return for an investor who purchased the bonds when they were issued and held them until they were called. Round your answer to two decimal places. %

B. Why the investor should or should not be happy that Templeton called them.

I. Since the bonds have been called, interest rates must have risen sufficiently such that the YTC is greater than the YTM. If investors wish to reinvest their interest receipts, they can now do so at higher interest rates.

II. Since the bonds have been called, interest rates must have risen sufficiently such that the YTC is greater than the YTM. If investors wish to reinvest their interest receipts, they must do so at lower interest rates.

III. Since the bonds have been called, investors will receive a call premium and can declare a capital gain on their tax returns.

IV. Since the bonds have been called, investors will no longer need to consider reinvestment rate risk.

V. Since the bonds have been called, interest rates must have fallen sufficiently such that the YTC is less than the YTM. If investors wish to reinvest their interest receipts, they must do so at lower interest rates.

Answer 1

answer:

A) calculation of realised rate of return / internal rate of return / YTC

period = n = 9

coupon tare = 12%

pmt = 12% of 1000 = 120

fv= 1080

pv = 1000

YTC = rate ( n, pmt, pv, fv) = rate (9, 120, -1000, 1080) = 12.53%

B) calculation of realised rate of return / internal rate of return / YTM

period = n = 17

coupon tare = 12%

pmt = 12% of 1000 = 120

fv= 1080

pv = 1000

YTM = rate ( n, pmt, pv, fv) = rate (17, 120, -1000, 1080) = 12.16%

hence, YTC > YTM. it indicates that investors should be happy if the bonds are called by the company.

Investors should be happy under option I. Since the bonds have been called, interest rates must have risen sufficiently such that the YTC is greater than the YTM. If investors wish to reinvest their interest receipts, they can now do so at higher interest rates.