Six years ago the Templeton Corpar y sued 28 year bonds with an 15% annual coupo

Question

Six years ago the Templeton Corpar y sued 28 year bonds with an 15% annual coupon rate at their $1,000 par value. The bonds had an 9% cal per of call protection. Today Templeton called the bonds. um, with 5 years a. Compute the realized rate of return for an investor who purchased the bonds when they were issued and held them until they were called. Round your answer to two decimal places. 12.11 b. Why the investor should or should not be happy that Templeton called them. 1· Since the bonds have been called interest rates must have nsen sufficently such that the YTcis greater than the YTM If investors wish to reinvest their interest receipts, they can now do so at higher interest rates. II. Since the bonds have been called, interest rates must have risen sufficiently such that the YTC is greater than the YTM. If investors wish to reinvest their interest receipts, they must do so at lower interest rates. III. Since the bonds have been called, investors will receive a call premiurn and can declare a capital gain on their tax returns. IV. Since the bonds have been called, investors will no longer need to consider reinvestnent rate risk. V. Sinoe the bonds have been called, interest rates must have fallen sufficiently such that the YTC is less than the YTM. If investors wish to reinvest their interest receipts, they must do so at lower interest rates.

Explanation / Answer

Ans a. The realised return is the return earned through coupon payments and the call premium.

In the given question,

Realised return = (Coupon payments each year + ((Amount received when called-amount paid)/Number of years bond was held)/(Amount received when called+Amount paid)/2

=(1000*15% + ((1000*1.09 - 1000)/6)/(1090+1000)/2

=(150 + 90/6)/1045

=165/1045

=15.79%

Ans b. Interest rates must have fallen which is why the company has called the bonds. The company would have taken a loan at a lower rate to repay the costlier bonds. Investors will not be happy as now if they want to reinvest their interest receipts, they will have to do it at lower rates. So the correct option is V.

Do let me know in case of any confusion.

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