Yield to call 12. a. Using the facts given in problem 11, what would be the yiel

Question

Yield to call

12. a. Using the facts given in problem 11, what would be the yield to call if the call can be made in four years at a price of $1,080? Use Formula 12–3 on page 321.

b. Explain why the answer is lower in part a than in problem 11.

c. Given a call value of $1,080 in four years, is it likely that the bond price would actually get to $1,160?

Facts in problem number 11 :

Approximate yield to maturity

11. What is the approximate yield to maturity of a 14 percent coupon rate, $1,000 par value bond priced at $1,160 if it has 16 years to maturity?

Explanation / Answer

12(a).

If the call is made on the 4th year, the income streams are

Coupon=140 from Y1 to Y4 and Call Price=1080. Let the YTM is Y.

So , 1000=140/(Y)+140(Y^2)+140/(Y^3)+140/(Y^4)+1080/(Y^4)

By trial and error , we get Y=19.40%

11.

By using short cut formulae:

YTM=(C+(M-P)/n)/(0.4M+0.6P)=(140+(1000-1160)/16)/(0.4*1000+0.6*1160)=11.86%

12(b)

The YTM is higher compated to (11)

12(c)

Since the yield has gone down from 19.4% to 11.86% incase of wait till maturity , the price will increase and would actually get $1160. Needless to mention Price of a bond is the discounted value of the case flows and with lower YTM , the value will increase.

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