Question

Problem 7-18 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 = $1,090). a. What is the yield to maturity? Round your answer to two decimal places. % b. What is the yield to call if they are called in 5 years? Round your answer to two decimal places. % c. Which yield might investors expect to earn on these bonds? Why? I. 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. III. Investors would expect the bonds to be called and to earn the YTC because the YTC is less than the YTM. IV. Investors 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. -Select- d. The bond's indenture indicates that the call provision gives the firm the right to call the bonds at the end of each year beginning in Year 5. In Year 5, the bonds may 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 face value; 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 is the latest that investors might expect the firm to call the bonds? In Year -Select- .

Answer 1

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| 0 = = = = = 3 g w ? v . 1 04:33 ENG 20-02-2020 - 23 X D750 A KAUFMAN 749 750 751 752 753 754 755 756 757 YEARS TO MATURITY FACE VALUE COUPON COUPON($) 10 1000 11% 110 1175 8.35% PV 758 a YTM (=RATE(C753,-C756,C757,-C754)] 759 IF CALLABLE IN 5 YEARS 760 b 761 762 763 YEARS TO CALL CALL PRICE YTC 1090 8.13% 764 (=RATE(C762,-C756,C757,-C763)] III Investors would expect the bonds to be called and to earn the YTC because the YTC is less than the YTM. 765 766 C : 767 768 769 770 771 772 IF CALLABLE IN 6 YEARS YEARS TO CALL CALL PRICE YTC 6 1080 8.27% [=RATE(C769,-C756,c757,-C770)] YIELD SPOT AFN BANKING NOTE Sheet251 53 CLEAN PRICE $10 BIDDING, UNDERWRITING EUAC AW LIFE LP, IP, MRP, INFLATION WARR... →

| 0 = = = = = 3 g w ? v . * 04:34 ENG 20-02-202023 - X B785 A 767 768 769 770 IF CALLABLE IN 6 YEARS YEARS TO CALL CALL PRICE YTC 6 1080 8.27% (=RATE(C769,-C756,0757,-C770)] 772 773 IF CALLABLE IN 7 YEARS YEARS TO CALL CALL PRICE YTC 1070 8.37% (=RATE(C774,-C756,0757,-C775)] 774 775 776 777 d 778 ANSWER 779 780 781 782 783 784 AS WE SEE, THE YTC IS INCREASING AS WE EXTEND THE CALL PERIOD THE YTC IS AT 8.13%, WHEN CALLED IN YEAR 5 THE YTC IS AT 8.27%, WHEN CALLED IN YEAR 6 COMPANY WILL LIKE TO CALL BONDS AS LONG AS YTC <YTM (8.35%) SO LATEST BY END OF 6TH YEAR, THE BOND WILL BE CALLED 785 786 787 788 789 YIELD SPOT AFN BANKING NOTE Sheet2 S1 S3 CLEAN PRICE $10 BIDDING, UNDERWRITING EUAC AW LIFE LP, IP, MRP, INFLATION WARR... 1