Problem:
It is now January 1, 2012, and you are considering the purchase of an outstanding bond that was issued on January 1, 2010. It has a 7.5% annual coupon and had a 30-year original maturity. (It matures on December 31, 2039.) There is 5 years of call protection (until December 31, 2014), after which time it can be called at 109-that is, at 109% of par, or $1,090. Interest rates have declined since it was issued; and it is now selling at 119.575% of par, or $1,195.75.
Requirement:
Question 1: What is the yield to maturity?
Question 2: What is the yield to call?
Question 3: If you bought this bond, which return would you actually earn? Explain your reasoning.
- Investors would not expect the bonds to be called and to earn the YTM because the YTM is greater than the YTC.
- Investors would not expect the bonds to be called and to earn the YTM because the YTM is less than the YTC.
- Investors would expect the bonds to be called and to earn the YTC because the YTC is less than the YTM.
- Investors would expect the bonds to be called and to earn the YTC because the YTM is less than the YTC.
- Investors would expect the bonds to be called and to earn the YTC because the YTC is greater than the YTM.
Question 4: 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?
- Investors would not expect the bonds to be called and to earn the YTM because the YTM is greater than the YTC.
- Investors would not expect the bonds to be called and to earn the YTM because the YTM is less than the YTC.
- Investors would expect the bonds to be called and to earn the YTC because the YTM is less than the YTC.
- Investors would expect the bonds to be called and to earn the YTC because the YTC is greater than the YTM.
- Investors would expect the bonds to be called and to earn the YTC because the YTC is less than the YTM.
Note: Please provide equation and explain comprehensively and give step by step solution.