ADMS 3531 Chapter Notes - Chapter 11: Cash Flow, Dirty Price, Reinvestment Risk
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A 20-year, 5.75% semiannual coupon bond with a par value of $1,000 may be called in 5 years at a call price of $1,060. The bond sells for $1,010. (Assume that the bond has just been issued.)
| Basic Input Data | |
|---|---|
| Years to Maturity: | 20 |
| Periods Per Year: | 2 |
| Periods to Maturity: | 40 |
| Coupon Rate: | 5.75% |
| Par Value: | $1,000 |
| Periodic Payment: | $28.75 |
| Current Price: | $1,010 |
| Call Price: | $1,060 |
| Years till Callable: | 5 |
| Periods till Callable: | 10 |
Yield to Maturity
| Periodic YTM = | 3.27% |
| Annualized Nominal YTM = | 6.55% |
Current Yield
| Current Yield = | Annual Coupon | Hint: Write formula in words. | |
| Current Yield = | / | $58 | Hint: Cell formulas should refer to Basic Input Data Section |
| Current Yield = | 0.0569 |
Yield to Call
| Peridodic YTC = | 2.91% | |
| Annualized Nominal YTC = | 5.83% | This is a nominal rate, not effective rate. Nominal rates are generally quoted. |
When the YTC is lower than the YTM and if the bond is called, the buyer will lose the difference between the call price and the current price between the purchase date and the call date, and that loss would offset much of the interest income. Note too that if the YTC is lower than the YTM then the bond is likely to be called and replaced, hence that the YTC would probably be earned.
| Nominal market rate, r: | 6% |
| Value of bond if it's not called: | $971.11 |
| Value of bond if it's called: | $1,033.98 |
a. Assume you have been asked to evaluate investing some excess cash into the bond described above. Recommend purchasing the bond or looking at another option. Defend your recommendation by explaining the items above.
b. How would the price of the bond be affected by changing the going market interest rate?
