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il63 [147K]
3 years ago
15

It is now January 1, 2013, and you are considering the purchase of an outstanding bond that was issued on January 1, 2011. It ha

s a 7 percent annual coupon and had a 30-year original maturity. (It matures on December 31, 2040.) There were 11 years of call protection (until December 31, 2021), after which time it can be called at 108.5 percent of par, or $1,085. Interest rates have fallen since the bond was issued, and it is now selling at 115.5 percent of par, or $1,155. If you bought this bond, what rate of return would you probably earn, assuming you hold the bonds until they either mature or are called
Business
1 answer:
frutty [35]3 years ago
3 0

Answer:

a. Assuming you hold the bonds until they mature, the rate of return you would probably earn is the YTM of 5.89%.

b. Assuming you hold the bonds until they are called, the rate of return you would probably earn is the YTC of 5.65%.

Explanation:

This can be determined by calculating the YTM and YTC as follows:

a. Calculation of Yield to Maturity (YTM)

The bond's Yield to Maturity can be calculated using the following RATE function in Excel:

YTM = RATE(nper,pmt,-pv,fv) .............(1)

Where;

YTM = yield to maturity = ?

nper = number of periods = number of years to maturity = 30

pmt = annual coupon payment = annual coupon rate * Face value = 7% * $1,000 = $70 = 70

pv = present value = current bond price = $1,155 = 1155

fv = face value or par value of the bond = 1000

Substituting the values into equation (1), we have:

YTM = RATE(30,70,-1155,1000) ............ (2)

Inputting =RATE(30,70,-1155,1000) into excel (Note: as done in the attached excel file), the YTM is obtained as 5.89%.

Therefore, assuming you hold the bonds until they mature, the rate of return you would probably earn is the YTM of 5.89%.

b. Calculation of Yield to Call (YTC)

The bond's Yield to call can be calculated using the following RATE function

in Excel:

YTC = RATE(nper,pmt,-pv,fv) .....................(3)

Where;

YTM = yield to call = ?

nper = number of periods = number of years of call protection = 11

pmt = annual coupon payment = annual coupon rate * Face value = 7% * $1,000 = $70 = 70

pv = present value = current bond price = $1,155 = 1155

fv = future value of the bond or the amount at which the bond can be called = $1,085 = 1085

Substituting the values into equation (3), we have:

YTM = RATE(11,70,-1155,1085) ............ (4)

Inputting =RATE(11,70,-1155,1085) into excel (Note: as done in the attached excel file), the YTM is obtained as 5.65%.

Therefore, assuming you hold the bonds until they are called, the rate of return you would probably earn is the YTC of 5.65%.

Download xlsx
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