Aa Aa 8. Bond yields Coupon payments are fixed, but the percentage return that i
ID: 2819678 • Letter: A
Question
Aa Aa 8. Bond yields Coupon payments are fixed, but the percentage return that investors receive varies based on market conditions. This percentage return is referred to as the bond's yield Yield to maturity (YTM) is the rate of return expected from a bond held until its maturity date. However, the YTM equals the expected rate of return under certain assumptions. Which of the following is one of those assumptions? O The bond is callable. O The gobability of default is zero. Consider the case of Eades Corp.: Eades Corp. has 9% annual coupon bonds that are callable and have 18 years left until maturity. The bonds have a par value of $1,000, and their current market price is $1,130.35. However, Eades Corp. may call the bonds in eight years at a call price of Value YTM YTC $1,060. What are the YTM and the yield to call (YTC) on Eades Corp.'s bonds? If interest rates are expected to remain constant, what is the best estimate of the remaining life left for Eades Corp.'s bonds? O 18 years O 5 years O 8 years O 10 years If Eades Corp, issued new bonds today, what coupon rate must the bonds have to be issued at par?Explanation / Answer
Answer:
Face value of bond=$1000
Annual Interest=1000*9%=90 p.a.
Time to Matuarity is 18 year
Reddemable value=$1000
YTM= AnnualInterest+ (Redeemable value-market value/Life)*100
Redeemable value+market value/2
= 90+ ($1000-$1130.35)/18*100
$1000+$1130.35/2
=90+(-7.24)/1065.15*100
=7.76%
We use two rates surrounding YTM 7.76%
suppose the discount rate is 8%
Present value of inflow=(Annual Interest*sum of pv factor for 18 year)+R.V.*p.v.f.18
= 90* 9.371+1130.35*0.250
=843.39+282.59
=1125.98
NPV= Present value of inflow- present value of outflow
=1125.98-1130.35= (-4.52)
ii Taking Lower Rate say 7%
Present value of inflow= (Annual Interest*sum of pv factor for 18 year)+R.V.*p.v.f.18
=(90*10.05+1130.35*0.295)
=904.5+333.45
=1237.95
NPV= Present value of inflow- present value of outflow
= 1237.95-1130.35
=107.6
YTM=Lower Rate + NPV at lower Rate / Npv at lower rate-npv at higer rate*(Difference in Rate)
=7%+ 107.6/107.6 - (-4.52)*8%-7%
YTM= 7.95%
YTC= Redeemable value-Call value/Life)*100
Redeemable value+Call value/2
= 90+ ($1000-$1060)/8*100
$1000+$1060/2
=90-7.5/1030*100
8%
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