You are considering an investment in the bonds of the Front Range Electric Compa

Question

You are considering an investment in the bonds of the Front Range Electric Company The bonds pay interest quarterly, will mature in 15 years, and have a coupon rate of 4.50% on a face value of $1,000. Currently, the bonds are selling for $950. 1- If the bonds can be called in three years with a call premium of 4% of the face value, what is the yield to call? (Use the RATE function.) Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-202 2- Now assume that the settlement date for your purchase is 7/30/2017, the maturity date is 7/30/2032, and the first call date is 7/30/2020. If market interest rates remain unchanged, do you think it is likely that the bond will be called in three years? Why or why not:? 3- Create a chart that shows the relationship of the bond's price to your required return. Use a range of 0% to 15% in calculating the prices. 4-

Explanation / Answer

1. Use RATE function in Excel.

Enter nper=12 (i.e. 4 quarters per year* 3 years), pmt=0, PV=-950 (current price of the bond), FV= 1040 (price at which bond will be called, i.e. 104%*1000)

This gives yield of 1.89% quarterly, annualizing it gives a yield to call of 7.56%

3. Since the bond is trading at a discount to face value, the current market rate of interest is greater than coupon rate. Here, market rate of interest is greater than coupon rate and if it remains unchanged, the bond is unlikely to be called as the current cost of borrowing is lower than the market rate.

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