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 rate

Answer 1

n	9
pmt	120
FV	1080
pv	-1000
YTC	12.53%

Excel formula:
=RATE(9,120,-1000,1080)

Customer should not be happy because the rates have fallen and templeton was offering a higher coupon rate than the market. Calling bonds shall end high coupon payment. Any new bond purchased by customer shall pay coupon at prevailing low market rates

Hence option V is correct:
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 rate