it is now march 1,2001, and you are considering the purchase of an outstanding K

Question

it is now march 1,2001, and you are considering the purchase of an outstanding Kramerko bond with a par value of $1000 that was issued March 1, 1999. the Kreamerko bond has a 9.5 percent annual coupon and a 30-year original maturity (it matures on February 28, 2029). there is a 5-year call protection period(untill February 28, 2014), after which the bond can be called at $1090. Interest rates have declined since the bond has been issued, and the bond is currently selling at $1165.75

1. what is the yield to maturity now in 2001 for the Kramerko bond?

2. what is the yield to call now in 2001 for the Kramerko bond>

3. if you bought this bond, which return do you think you would actually earn? explain your reasoning

4. suppose the bond has sold at a discount. would the yield to maturity or yield to call have been more relrevant?

Explanation / Answer

1. Yield to maturity = {Interest + (Maturity Value-Issue Value)/n} / {(Maturity Value +Issue Value)/2}

By applying above equation, Ytm= {95+(1090-1000)/28} / {(1090+1000)/2

YTM = 9.40%

2. Yield to Call (YTC) = Interest + (Call Value - B0 )/ Call Years

(Call Value + B0) /2

= 95 +(1090-1165.75)/13

(1090+1165.75)/2

YTC = 7.91%

3. Return depends upon the period of holding of Bond. If bond is sold in 2014, Return will be @ 7.91%. On the other hand if held upto the date of maturity, Return will be @ 9.4%

4. If bond is sold at discount, its coupon rate will be less than YTM. Hence YTM and YTC in this case will not be more relevant.

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