Exxon Mobil issues two bonds with 20-year maturities. Both bonds are callable at $1,050. The rst bond is issued at a deep discount with a coupon rate of 4% and a price of $580 to yield 8.4%. The second bond is issued at par value with a coupon rate of 8.75%.
(a) What is the yield to maturity of the par bond?
(b) In the same graph, draw the prices of each of the two bonds issued by Exxon Mobil. Note: page 50 in lecture 10 shows how the price of a callable bond looks like.
(c) If you expect rates to fall substantially in the next two years, which bond is more likely to be called? Defend your answer.
(d) What is the capital gain on the 8.75% coupon bond if rates in the next two years fall enough so that this bond is called?
(e) If you expect rates to fall substantially in the next two years, which bond would you prefer to hold?
(f) Why is the yield to maturity of the par bond higher than the yield of the discount bond? Defend your answer.