Question

Ten years ago the Templeton Company issued 16-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? 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. 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. 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. Investors should be happy. Since the bonds have been called, investors will no longer need to consider reinvestment rate risk.

Answer 1

the realized rate of return for an investor who purchased the bonds when they were issued and held them until they were called = YTC = Rate (Nper, PMT, PV, FV) = Rate (10, 10% x 1000, -1000, 1000 x (1 + 9%)) = 10.55%

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A bond is usually called by the issuer only when the interest rates have dropped significantly, since the time bond was issued. An investor is usually not happy with the bonds being called, because he / she is now stuck with his money in a low interest rate scenario.

Hence, the correct answer should be:

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.