2 A 1000 face value corporate bond has a 10year maturity and

2. A $1000 face value corporate bond has a 10-year maturity and pays interest annually. The coupon rate is 5%, and the bond is priced at $1000. The bond is callable in 5 years at 110% of par. a. What is the bond\'s (a) YTM and (b) YTC? b. If bond market interest rates remain unchanged, will you earn the YTC? Explain.

Solution

a.

As bond price is trading at par value or face value the YTM = Coupon rate = 5%

(a)    YTM = 5.00%

(b)    YTC = 6.75%

Working for YTC:

Using financial calculator BA II Plus - Input details:

#

FV = Call price = FV x 110% =

$1,100.00

PV = Bond price =

$1,000.00

PMT = Coupon =

$50.00

N = Year to call =

5

CPT > I/Y = Rate =

                   6.7477

Yield to call or Return Investors should expect to earn in % =

6.75%

b.

No, we will not earn YTC.

If interest rates are unchanged then the issuer will never call the bond because issuer will have to pay at 6.75% rate (YTC) where as market rate is 5%.

Hence, we will not earn YTC.

Using financial calculator BA II Plus - Input details:	#
FV = Call price = FV x 110% =	$1,100.00
PV = Bond price =	$1,000.00
PMT = Coupon =	$50.00
N = Year to call =	5
CPT > I/Y = Rate =	6.7477
Yield to call or Return Investors should expect to earn in % =	6.75%