Question

YIELD TO MATURITY AND YIELD TO CALL Kaufman Enterprises has bonds outstanding
with a $1,000 face value and 10 years left until maturity. They have an 11% annual coupon
payment, and their current price is $1,175. The bonds may be called in 5 years at 109% of
face value (Call price ¼ $1,090).

d. The bond ’ s indenture indicates that the call provision gives the firm the right to callthe bonds at the end of each year beginning in Year 5. In Year 5, the bondsmay be called at 109% of face value; but in each of the next 4 years, the call percentage will decline by 1%. Thus, in Year 6, they may be called at 108% of facevalue; in Year 7, they may be called at 107% of face value; and so forth. If the yield curve is horizontal and interest rates remain at their current level, when isthe latest that investors might expect the firm to call the bonds?

Answer 1

Par Value of theBond	$1,000
Number of Years toMaturity	10 years
Annual Coupon Rate	11%
Current Price of theBond	$1,175
Call Price of the Bond	$1,090
CalculatingYTM:
(Using Ms-Excel "RATE"Function):
Number of Periods	10
Annual Coupon Payment [$1,000 *11%]	-$110
Present Value of theBond	$1,175
Future Value (or) Par Value of theBond	-$1,000
Rate of Return on the Bond(RATE)	8.35%
Calculating YTC (Yield ToCall)
(Using Ms-Excel "RATE"Function):
Number of Periods	5
Annual Coupon Payment [$1,000 *11%]	-$110
Present Value of theBond	$1,175
Future Value (or) Par Value of theBond	-$1,090
Rate of Return on the Bond(RATE)	8.13%
Yield to Maturity on theBond (YTM)	8.35%
Yield to Call on theBond (YTC)	8.13%
if the Bond is a PremiumBond	YTM > YTC
if the Bond is a DiscountBond	YTM < YTC
Note: Here, the Bond isa Premium Bond. Thus, the Yield to Maturity (YTM) is greater thanthe Yield to Call (YTC).