Question

Harbuck’s Coffee semi-annual coupon, $1,000 par value bonds have 15 years to maturity. The bond’s annual coupon rate is 7% and they sell for $1,035 each. These bonds can be called in 3 years at a call price of $1,050. What is the bond’s yield to call? What is the bond’s yield to maturity? Which return would you expect to earn?

Answer 1

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

N = 3*2 = 6;

PV = -1035;

PMT = (7%/2)*1000 = 35;

FV = 1050;

Press CPT, then I/Y, which gives us 3.60

Periodic Rate = 3.60%

So, YTC = Periodic Rate * No. of compounding periods in a year = 3.60% * 2 = 7.20%

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

N = 15*2 = 30;

PV = -1035;

PMT = (7%/2)*1000 = 35;

FV = 1000;

Press CPT, then I/Y, which gives us 3.31

Periodic Rate = 3.31%

So, YTM = Periodic Rate * No. of compounding periods in a year = 3.31% * 2 = 6.63%

c). Since, the YTC is more than the YTM, investors would not expect the bonds to be called and to earn the YTM.