Question

You're considering an investment in 12-year, $1,000 face value bonds with a 8.50% coupon paid annually and a yield to maturity of 7.50%. The bonds are callable in three years at a call price of $1,075. If you believe that the bonds will be called how much will you earn? Select one: a. 7.82% b. 7.50% 0.563% d. 10.75% e. 7.88% o

Answer 1

First calculate the price of bond or PV of the bond:

Using financial calculator BA II Plus - Input details:	#
I/Y = R = Rate or yield / frequency of coupon in a year =	7.500000
PMT = Coupon rate x FV / frequency =	-$85.00
N = Number of years remaining x frequency =	12
FV = Future Value =	-$1,000.00
CPT > PV = Present value of bond =	$1,077.35
Formula for bond value = |PMT| x ((1-((1+R%)^-N)) / R%) + (|FV|/(1+R%)^N)	$1,077.35

How much return we would earn if bond is called:

Using financial calculator BA II Plus - Input details:	#
FV = Call price =	$1,075.00
PV = Bond price =	$1,077.35
PMT = Coupon =	$85.00
N = Year to call =	3
CPT > I/Y = Rate =	7.8223
Yield to call or Return Investors should expect to earn in % =	7.82%

Correct option is > 7.82%