Question

It is now January 1, 2018, and you are considering the purchase of an outstanding bond that was issued on January 1, 2016. It has a 7.5% annual coupon and had a 30-year original maturity. (It matures on December 31, 2045.) There is 5 years of call protection (until December 31, 2020), 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 issued, and it is now selling at 119.575% of par, or $1,195.75. a. What is the yield to maturity? Do not round intermediate calculations. Round your answer to two decimal places. What is the yield to call? Do not round intermediate calculations. Round your answer to two decimal places. b. If you bought this bond, which return would you actually earn? Select the correct option. 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- c. 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 the yield to call have been most likely? 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 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 eenect the hands to be called and to earn the VIC because the YTC is less than the YTM Type here to search o * e @ N OW (2) A = 5:20 PM = d) 2/28/20

Answer 1

a]

YTM is calculated using RATE function in Excel with these inputs :

nper = 28 (28 years to maturity with 1 annual coupon payment each year)

pmt = 1000 * 7.5% (annual coupon payment = face value * annual coupon rate. This is a positive figure as it is an inflow to the bondholder)

pv = -1195.75 (current bond price. This is a negative figure as it is an outflow to the buyer of the bond)

fv = 1000 (face value of the bond receivable on maturity. This is a positive figure as it is an inflow to the bondholder)

The RATE is calculated to be 6.03%. This is the YTM.

A1 X fix =RATE(28,1000*7.5%,-1195.75, 1000) D E F G B C A 6.03% 11

YTC is calculated using RATE function in Excel with these inputs :

nper = 3 (3 years to first call date with 1 annual coupon payment each year)

pmt = 1000 * 7.5% (annual coupon payment = face value * annual coupon rate. This is a positive figure as it is an inflow to the bondholder)

pv = -1195.75 (current bond price. This is a negative figure as it is an outflow to the buyer of the bond)

fv = 1090 (call price of the bond receivable on call date. This is a positive figure as it is an inflow to the bondholder)

The RATE is calculated to be 3.42%. This is the YTC.

A1 X fac =RATE(3,1000*7.5%,-1195.75,1090) D E F G B C A 3.42% 1

b]

The bond would likely be called because interest rates have declined since the bond was issued (YTM is less than coupon rate). Hence, investors would earn the YTC as the YTC is less than YTM

The answer is III

c]

The bond would likely not be called because if the bond were selling at a discount, the YTM would be more than the coupon rate. In this case, YTM would be the most likely return.

The answer is I