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Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937

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Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937
Textbook Problem
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YIELD TO CALL It is now January 1, 2016, and you are considering the purchase of an outstanding bond that was issued on January 1, 2014. It has an 8% annual coupon and had a 30-year original maturity. (It matures on December 31, 2043.) There is 5 years of call protection (until December 31, 2018), after which time it can be called at 108—that is, at 108% of par, or $1,080. Interest rates have declined since it was issued, and it is now selling at 119.12% of par, or $1,191.20.

  1. a. What is the yield to maturity? What is the yield to call?
  2. b. If you bought this bond, which return would you actually earn? Explain your reasoning.
  3. 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?
  4. d.

a.

Summary Introduction

To identify: Yield to Maturity (YTM) and Yield to Call (YTC).

Yield to Maturity (YTM):

It is the rate of interest earned till the maturity of the bond by the bondholder.

Yield to Call:

It is the rate of interest earned until the bonds are being called, but before maturity of the bond.

Explanation

Given,

Coupon rate is 8%.

Selling price (value of bond) is $1,191.20.

Par value of bond is $1,000.

Maturity is after 30 years.

Yield to maturity (YTM) can be calculated through value of bond.

Formula to calculate present value of bond,

Bond'svalue=t=1NINT(1+rd)t+Parvalue(1+rd)N

Where,

  • INT is the interest rate
  • N is the number of year for maturity.
  • Rd is the rate of discount.

Table (1)

Hence, Yield to Maturity is 6.50%.

Yield to call:

Yield to call (YTC) can be calculated through value of bond

b.

Summary Introduction

To identify: Actual return on purchase of the given bond.

Yield to Maturity (YTM):

It is the rate of interest earned till the maturity of the bond by the bondholder.

Yield to Call:

It is the rate of interest earned until the bonds are being called, but before maturity of the bond.

c.

Summary Introduction

To identify: Whether the Yield to Maturity has been the most likely return if the bond is sold at discount.

Yield to Maturity (YTM):

It is the rate of interest earned till the maturity of the bond by the bondholder.

Yield to Call:

It is the rate of interest earned until the bonds are being called, but before maturity of the bond.

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