Question

It is now January 1, 2021, and you are considering the purchase of an outstanding bond that was issued on January 1, 2019. It has a 7.5% annual coupon and had a 30-year original maturity. (It matures on December 31, 2048.) There is 5 years of call protection (until December 31, 2023), after which time it can be called at 108-that is, at 108% of par, or $1,080. Interest rates have declined since it was issued, and it is now selling at 119.57% of par, or $1,195.70.

I. What is the yield to maturity? Do not round intermediate calculations. Round your answer to two decimal places. ____%
II. What is the yield to call? Do not round intermediate calculations. Round your answer to two decimal places. %

Answer 1

The question requires the calculation of yield to maturity and yield to call for a bond bought at a premium. These calculations consider the bond's premium price, annual coupon, and call protection period, accounting for the change in market interest rates.

Step-by-step explanation:

The question at hand involves calculating both the yield to maturity (YTM) and the yield to call (YTC) for a bond. To determine these yields, bond pricing formulas or financial calculators are typically utilized. The YTM is the total return anticipated on a bond if it is held until the end of its maturity. The YTC, however, is the total return anticipated if the bond is held until the call date, which is the date when a bond issuer can redeem callable bonds before they reach their maturity date.

In this instance, we were presented with a bond purchased above its face value (at a premium), which signifies that the interest rates have declined since issuance, making the bond more valuable due to its higher coupon rate relative to the market.