Venture Corp issued 7 year 5% bonds due 2023 at par. This bond pays interest on
ID: 2759714 • Letter: V
Question
Venture Corp issued 7 year 5% bonds due 2023 at par. This bond pays interest on a semi-annual basis. However, right after Venture issued the bonds, the Company missed its first earnings and at the same time, the interest rate environment changed. Now the market’s required return has increased to 9% (all else being equal). In this current environment, what is the trading price of the bond? Is this bond trading at a discount or premium? (5 points) Now suppose you find out that the Venture Corp bonds are callable in 3 years at 101% (or $1010). Assuming the trading price you found above, what is the bond’s yield to call? Is the yield to call or yield to maturity higher? Why? (Hint: the yield to call is the yield you get if you hold the bond until the call date and you get paid the call price ) (5 points) Venture Corp is considering two identical 7year bonds except one had a call and the other was noncall. Which one should be more expensive( higher yield) to issue for Venture Corp and why? (Hint think about the motivation for exercising the call and its impact on bondholders) (5 points)
Explanation / Answer
B0 = the bond price,
C = the annual coupon payment,
F = the face value of the bond,
YTM = the yield to maturity on the bond, and
t = the number of years remaining until maturity.
Bond Value = C/2 {[1-(1+(YTM/2))-2t/(YTM/2)] + [F / (1+ (YTM/2))2t]
B0 = ?
C = $1,000 x 5% = $50
F = $1,000
YTM = 9%
t = 7
Bond Value = $50/2 {[1-(1+(9%/2))-14/(9%/2)] + [$1,000 / (1+ (9%/2))14] = $796.00
As the trading price is less than the face value, it’s trading at discount.
Yield to Call:
Annual Interest = $1,000 x 5% = $50
Call Price = $1,010
Market Price = $796.00
Number of Years to Call = 3 Years
= {($50) + [($1010 - $796)/(3)]} / {[$1010 + $796]/2} = 13.44%
The YTM is 9%, while YTC is 13.44%, so YTC is higher.
Other things remaining constant, the bond with a call option is always more expensive than a non-callable bond.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.