Question

Ten years ago the Templeton Company issued 20-year bonds with a 10% annual coupon rate at their $1,000 par value. The bonds had a 9% call premium, with 5 years of call protection. Today Templeton called the bonds. 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.

_____%

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

I. Investors should not be happy. 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.

II. Investors should be happy. 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.

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

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

Answer 1

Answer : Calculation of Realized Rate of Return

Using Rate function of Excel :

=RATE( nper,pmt,pv,fv)

where

nper is Number of year completed i.e 10

pmt is the periodic coupon payment i.e 100 (1000 * 10%)

pv is the present value i.e 1000

fv is the call price i.e 1090 (1000 + 9%)

=RATE( 10,100,-1000,1090)

Realized Rate of return is 10.55%

Correct option is I. Investors should not be happy. 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.