Question

YIELD TO CALL f call Nine years ago the Templeton Company issued 30-year bonds with an 12% annual coupon rate at their $$1,000 par value. The bonds had an 8% call premium, with 5 years protection. Today Templeton called the bonds a. Compute the realized rate of return for an investor who purchased the bonds when they were issued and held them until they were called. Round your answer to two decimal places. b. Why the investor should or should not be happy that Templeton called them. I. Since the bonds have been called, interest rates interest receipts, they can now do so at hiqher interest rates ust have risen sufficiently such that the YTC is greater than the YTM. If investors wish to reinvest their II intorast Donds einteract u ave risen sufficiently such that the YTC is greater than the YTM, If investors wish to reinvest their capital gain on their tax returns. III. Since the bonds have been called, investors will receive a call premium and can declare IV. Since the bonds have been called, investors will no longer need to consider reinvestment rate risk. v. Since the bonds have been called, interest rates must have fallen sufficiently such that the YTC receipts, they must do so at lower interest rates. less than the YTM. If investors wish to reinvest their interest Select-

Answer 1

#of years held to call, NPER [From the year the bond was issued initally to the current year when bond is called] a $120 [$1,000 x 12% as coupons are payable on bond's par value only] $1,000 [As it was issued at par value] $1,080 [$1,000 x 108% as it involves 8% call premium] 0 0 if coupons paid at the end of each year; 1 if coupons paid at the beginning of each year Annual coupon payments, PMT Bond's initial purchase price, PV Bond's call value today, FV Annual interest type, TYPE Bond's Yield to Call (YTC) 12.53% [Ref: NOTE] NOTE: Bond's Yield to Call (YTC) is calculated using EXCEL FUNCTION RATE(nper,pmt,pv,fv,type) where nper-9; pmt--120; pv-1000; fv=-1080; type-0; Here, value for pmt & fv are negative as they denote cash inflows; pv is positive as it denotes outflow; type 0 as coupons paid at the end of each year only. A C 1 #of years held to call, NPER 9 [From the year the bond was issued initally to the current year when bond called] -1000*12 % [ $1 ,000 x 12% as coupons are payable on bond's par value onlyl $1,000 [As it was issued at par value] -B3*108% [ $1,000 x 108% as it involves 8% call premium] 2 Annual coupon payments, PMT Bond's initial purchase price, PV Bond's call value today, FV 3 4 5 Annual interest type, TYPE 0 0 if coupons paid at the end of each year; 1 if coupons paid at the beginning of each year. =RATE (B1,-B2,B3,-B4,B5) [Ref: NOTE Bond's Yield to Call (YTC) 6

b) Option-V: Since the bonds have been called, interest rate must have fallen sufficiently such that the YTC is less than the YTM. If the investors wish to reinvest their interest receipts, they must do so at lower interest rate. NOTE: YTM was 12% (=Coupon rate as the bond was initially issued at par) whereas YTC is 12.53%. Therefore, investors would be happy when bonds' are called more than YTC. As the bonds are called called today, it is obvious that interest rate would have fallen significantly. As a result, investors would like to invest in much lower interest rate environment and so Option-V correctly describes this fact