Chapter 7, Problem 12P

### Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

Chapter
Section

### Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

# YIELD TO CALL 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 an 8% 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 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 SI,191.20. a. What is the yield to maturity? What is the yield to call? b. If you bought this bond, which return would you actually earn? Explain your reasoning. 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?

a)

Summary Introduction

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

Introduction:

Yield to Maturity (YTM) refers to the total return expected on the bond till it matures.

Yield to Call refers to the yield of the bond if the investor buys and holds the stock or security till the call date. This yield is considered as valid if the security is called only before the maturity.

Explanation

Given information:

Coupon rate is 8%, selling price (value of bond) is \$1,191.20, par value of bond is \$1,000, and the maturity is after 30 years.

Note: The bonds are issued on 1st January 2016 but now the date is 1st January 2018. The given maturity period is 30years and therefore, the number of years will be 28 years. Refer excel for the below calculations.

Compute the yield to maturity:

b)

Summary Introduction

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

c)

Summary Introduction

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

Introduction:

Yield to Maturity (YTM) refers to the total return expected on the bond till it matures.

Yield to Call refers to the yield of the bond if the investor buys and holds the stock or security till the call date. This yield is considered as valid if the security is called only before the maturity.

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