Seven years ago the Singleton Company issued 26-year bonds with a 11% annual cou

Question

Seven years ago the Singleton Company issued 26-year bonds with a 11% annual coupon rate at their $1,000 par value. The bonds had a 5% call premium, with 5 years of call protection. Today Singleton called the bonds.

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.

%

Explain why the investor should or should not be happy that Singleton called them.

A.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 can now do so at higher interest rates.

B.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.

C.Since the bonds have been called, investors will receive a call premium and can declare a capital gain on their tax returns.

D.Since the bonds have been called, investors will no longer need to consider reinvestment rate risk.

E.Since 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

Bond is generally called when the market rate becomes lower than coupon rate soo that the company can retire the debt and borrow at alower cost.

So the statement E is true. The investors would not be happy as the current interest rate and YTC is lower than YTC and they have to reinvest the receipts at lower interest rate,

Correct statement:

E.Since 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.

Details Amt $ Bond Call price @5 % Premium=                                       1,050 Bond Purchase Price=                                       1,000 Capital Gain                                               50 Interest income @$110 for 7 years=                                          770 Total Return in 7 years=                                          820 Total Return % in 7 years= 82.00% Compounding factor in 7 yrs=1820/1000=1.82 from FVIF chart , the interets rate pertaining to 7 years and compunding factor 1.82 is 8.9% Average return per year = 8.90%

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