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Fundamentals of Financial Manageme...

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

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

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

YIELD TO MATURITY AND YIELD TO CALL Kempton Enterprises has bonds outstanding with a $1,000 face value and 10 years left until maturity. They have an 11% annual coupon payment, and their current price is $1,185. The bonds may be called in 5 years at 109% of face value (Call price = $1,090).

  1. a. What is the yield to maturity?
  2. b. What is the yield to call if they are called in 5 years?
  3. c. Which yield might investors expect to earn on these bonds? Why?
  4. d. The bond’s indenture indicates that the call provision gives the firm the right to call the bonds at the end of each year beginning in Year 5. In Year 5, the bonds may be called at 109% of face value; but in each of the next 4 years, the call percentage will decline by 1%. Thus, in Year 6, they may be called at 108% of face value; in Year 7, they may be called at 107% of face value; and so forth. If the yield curve is horizontal and interest rates remain at their current level, when is the latest that investors might expect the firm to call the bonds?

a.

Summary Introduction

To identify: Yield to maturity (YTM).

Yield to Maturity (YTM):

Yield to Maturity refers to the rate of interest earned till the maturity of the bond by the bond holder.

Explanation

Given,

The coupon rate is 11%.

Selling price (value of the bond) is $1,185.

Par value of the bond is $1,000.

Maturity is after 10 years.

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

The formula to calculate the present value of the bond,

Bond'svalue=t=1NINT(1+rd

b.

Summary Introduction

To identify: Yield to call (YTC).

Yield to Call:

Yield to Call refers to the rate of interest earned until the bonds are being called, but before maturity of the bond.

c.

Summary Introduction

To identify: The expected yield on these bonds.

Expected interest rate:

The rate of interest expected by the investors is said to be expected interest rate. It is affected by factors like market performance.

d.

Summary Introduction

To identify: The latest expected years of call.

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