Q-10-321
Expert-verifiedQuestion: A 30-year maturity, 8% coupon bond paying coupons semi-annually is callable in five years at a call price of $1,100. The bond currently sells at a yield to maturity of 7% (3.5% per half-year):
a. What is the yield to call?
b. What is the yield to call if the call price is only $1,050?
c. What is the yield to call if the call price is $1,100 but the bond can be called in two years instead of five years?
Answer
a. Yield to call is 3.368% semi-annually, 6.736% annually
b. Yield to call is 2.976% semi-annually, 5.952% annually
c. Yield to call is 3.031% semi-annually, 6.062% annually
Given [n = 60; i = 3.5; FV = 1000; PMT = 40]
Therefore the bond sells for $1,124.72 based on the 3.5% yield to maturity:
Given, now [n = 10; PV = 1124.72; FV = 1100; PMT = 40]
Therefore, yield to call is 3.368% semi-annually, 6.736% annually:
In this scenario, FV = $1050
Therefore yield to call is 2.976% semi-annually, 5.952% annually.
With a lower call price, the yield to call is lower.
In this case, given [n = 4; PV = 1124.72 ; FV = 1100; PMT = 40]
Hence, Yield to call is 3.031% semi-annually, 6.062% annually:
Question: Assume that two firms issue bonds with the following characteristics. Both bonds are issued at par.
ABC Bond | XYZ Bond | |
Issue size | 1.2 Billion | 150 Million |
Maturity | 10 Years* | 20 Years |
Coupon | 9% | 10% |
Collateral | First Mortgage | General Debenture |
Callable | Not callable | In 10 Years |
Call Price | None | 110 |
Sinking fund | None | Starting in 5 Years |
Bond is extendable at the discretion of the bondholder for an additional 10 years. |
Ignoring credit quality, identify four features of these issues that might account for the lower coupon on the ABC debt. Explain.
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