Question

Interest rates have declined since it was issued, and it is now selling at 119.575% of par, or $1,195.75.

a. What is the yield to maturity? Do not round intermediate calculations. Round your answer to two decimal places. % What is the yield to call? Do not round intermediate calculations. Round your answer to two decimal places. %
b. If you bought this bond, which return would you actually earn? Select the correct option.
I. Investors would not expect the bonds to be called and to earn the YTM because the YTM is greater than the YTC.
II. Investors would not expect the bonds to be called and to earn the YTM because the YTM is less than the YTC.
III. Investors would expect the bonds to be called and to earn the YTC because the YTC is less than the YTM.
IV. Investors would expect the bonds to be called and to earn the YTC because the YTM is less than the YTC.
V. Investors would expect the bonds to be called and to earn the YTC because the YTC is greater than the YTM.
c. Suppose the bond had been selling at a discount rather than a premium. Would the yield to maturity have been the most likely return, or would the yield to call have been most likely?
I. Investors would not expect the bonds to be called and to earn the YTM because the YTM is greater than the YTC.
II. Investors would not expect the bonds to be called and to earn the YTM because the YTM is less than the YTC.
III. Investors would expect the bonds to be called and to earn the YTC because the YTM is less than the YTC.
IV. Investors would expect the bonds to be called and to earn the YTC because the YTC is greater than the YTM.
V. Investors would expect the bonds to be called and to earn the YTC because the YTC is less than the YTM.

Answer 1

The yield to maturity (YTM) and yield to call (YTC) are essential for estimating returns on a bond. If interest rates have decreased and the bond is selling at a premium, YTM is likely less than YTC, leading investors to anticipate a bond call. Conversely, if a bond sells at a discount, investors would typically expect not to earn the YTC as the YTM offers a better return.

Step-by-step explanation:

When assessing the value and potential returns of a bond, investors must consider both the yield to maturity (YTM) and the yield to call (YTC). Given that a bond is currently selling at a premium, it indicates the coupon rate is higher than the prevailing market interest rates. The YTM calculation would take into account the premium paid over the bond's par value, interest payments, and the length of time until maturity. The YTC, on the other hand, assumes the bond is called at the earliest opportunity provided in the bond's terms.

Without the specific numerical data related to the actual coupon payments, call price, and years to maturity or call, we cannot provide exact figures for YTM and YTC. However, as a general principle, if the YTM is less than the YTC, investors would expect the bond to be called because they would earn a higher return if the bond is redeemed early. Conversely, if the YTM is greater than the YTC, investors would not expect the bond to be called as the return to maturity is greater.

If a bond is selling at a discount (less than its face value), it usually implies that the prevailing market interest rates are above the bond's coupon rate. In such cases, the YTM is more likely to represent the return an investor would earn, as companies are less likely to call bonds that would require them to issue new debt at higher interest rates.