Question

Check My Work (a remaining 7-4: Bond Yields Yield to call It is now January 1, 2014, and you are considering the purchase of an outstanding bond that was issued on January 1, 2012. It has a 7.5% annual coupon and had a 30-year original maturity. ( m ures December 31, 2041.) There is 5 years of call protection (until December 31, 2016), after which time it can be called at 109-that is, at 109% of par, or $1,090. Interest rates have declined since it was and it is now selling at 119.575% of par, or $1,195.75. a. What is the yield to maturity? Round your answer to two decimal places. What is the yield to call? Round your answer to two decimal places. b. If you bought this bond, which return would you actually earn? Explain your reasoning 1. Investors would not expect the bonds to be called and to earn the YTM because the YTM is greater than the YTC. II. Investors would not expect the bonds to be called and to earn the YTM because the YTM is less than the YTC. TIL Investors would expect the bonds to be called and to earn the YTC because the YTC is less than the YTM IV. Inwestors would expect the bonds to be called and to earn the YTC because the YTM is less than the YTC. V. Investors would expect the bonds to be called and to earn the YTC because the YTC is greater than the YTM ? Suppose the bond had been selling at a discount rather than a premium. Would the yield to maturity have been the most likely return, or would thered to cave been most 1. Investors would not expect the bonds to be called and to earn the YTM because the YTM is greater than the YTC. 11. Investors would not expect the bonds to be called and to earn the YTM because the YTM is less than the YTC III. Investors would expect the bonds to be called and to earn the YTC because the YTM is less than the YTC. IV. Investors would expect the bonds to be called and to earn the YTC because the YTC is greater than the YTM V. Investors would expect the bonds to be called and to earn the YTC because the VTC less than the YTM Select Check My Work a remaining)

Answer 1

a-1). To find the YTM, we need to put the following values in the financial calculator:

N = 30-2 = 28;

PV = -1195.75;

PMT = 7.5%*1000 = 75;

FV = 1000;

Press CPT, then I/Y, which gives us 6.03

So, YTM = 6.03%

a-2). To find the YTC, we need to put the following values in the financial calculator:

N = 5-2 = 3;

PV = -1195.75;

PMT = 7.5%*1000 = 75;

FV = 1090;

Press CPT, then I/Y, which gives us 3.42

So, YTC = 3.42%

b). Option "III" is correct.

As the YTC is less than YTM, the investors would expect the bonds to be called and will earn the YTC.

c). Option "I" is correct.

If the bond had sold at a discount, this would imply that current interest rates are above the coupon rate (i.e., interest rates have risen). Therefore, if interest rates remained at levels at or above the coupon rate the company would not call the bonds, so the YTM would be more relevant than the YTC.