Question

Yield to maturity (YTM) is the rate of return expected from n bond held until its maturity date. However, the YTM equals the expected rate of return under certain assumptions. Which of the following is one of those assumptions? The bond has an early redemption feature The bond will not be called Consider the case of Demed Inc Demed Inc. has 9% annual coupon bonds that are callable and have 18 years left inl matarity The bonds have a per value af $1,000, and their current market price is $1,190.35. However, Demod Inc. may call the bonds ih esttht vears at a coll price of $ 1,060 Whot are the YTM and the yield to call IYTC) on Demed Inc.'s bonds? Value STM YTC E interest rates are expected to remain constant, whiot is the best estimato ot thretbleand fe et or hed ine s bonds 18 yeers 5 yenrs 13 years 8 vears It Demed Inc, ased new lionds today, what coupon rate must thd bends hae to be issuod at par?

Answer 1

Answer is: The bond will not be called. YTM is the return that will be earned on a bond if the bond is purchased at the current market price and is held till maturity. Thus, on the basis of this definition of YTM, the assumption under which YTM equals the required rate of return is, if the bond is not called. It means it is held until maturity. Calculate the YTM and YTC on the bonds as follows: A 1000 1190.35 18 1 Par value 2 Current market price 3 Years left to maturity 4 Number of years to call 5 Call price 6 Coupon rate 7 CALCULATIONS: 1060 0.09 Coupon payment 8 (Coupon rate* Par value) 9 YTM 10 YTC =B1*B6 =RATE(B3,B8,-B2,B1) =RATE(B4,B8,-B5,B1) The answers are as follows:

$1,000.00 $1,190.35 18 1 Par value 2 Current market price 3 Years left to maturity 4 Number of years to call 5 Call price 6 Coupon rate 7 CALCULATIONS: $1,060.00 9% Coupon payment 8 (Coupon rate* Par value) $90.00 9 YTM 7.09472% 10 YTC 7.95759% Hence, YTM is 7.09% and YTC is 7.96% (rounded off to 2 decimal places). The best estimate of remaining life of the bond is 18 years.