Question

Taussig Corp.'s bonds currently sell for $1,150. They have a 6.75% annual coupon rate and a 15-year maturity, but they can be called in 6 years at $1,067.50. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. Under these conditions, what rate of return should an investor expect to earn if he or she purchases these bonds, the YTC or the YTM?

Make sure to describe how to do it on a financial calculator, thanks.

Answer #1

If the coupon rate exceeds the YTM, then it is likely that the bonds will be called and replaced with new, lower coupon bonds. In that case, the YTC will be earned. Otherwise, one should expect to earn the YTM.

If held to maturity: | If called: | |||

Par value $1,000 | Par value $1,000 | |||

Coupon 6.75% | Coupon 6.75% | |||

N 15 | N 6 | |||

PV $1,150.00 | PV $1,150.00 | |||

PMT $67.50 | PMT $67.50 | |||

FV $1,000.00 | FV $1,067.50 | |||

I/YR 5.28% YTM | I/YR 4.81% YTC |

Yield To Maturity=

Coupon Payment+Face value (FV)-Market price(P) by
years to maturity(n) Whole divided by Face
value(FV)+Market price(p)/2 |

F=Face value |

C= Coupon payment |

P=Price |

n=years to maturity |

6.75%+$ 1067.5-1000/6/$1067.50+1000/2 |

After Simplifying we get 4.81%

Expected rate of return : 4.81% YTC.

Please give feedback on this. thanks!

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