Question

Lloyd Corporation's 12% coupon rate, semiannual payment, $1,000 par value bonds, which mature in 20 years, are callable 4 years from today at $1,075. They sell at a price of $1,244.57, and the yield curve is flat. Assume that interest rates are expected to remain at their current level.

Answer 1

The question discusses the yield of bonds and their pricing in relation to changes in the market interest rate. It explains that bonds will sell at a discount or a premium, depending on whether market interest rates have risen or fallen since the bond's issuance. It also illustrates how the yield to maturity is calculated to equalize with the market rate for investors.

Step-by-step explanation:

The question relates to understanding the pricing mechanism of bonds and the concept of yield to maturity when interest rates in the market change. When interest rates rise, an existing bond with a lower coupon rate becomes less attractive, and thus it must be sold at a discount to offer an equivalent yield to attract buyers. Conversely, if market rates fall, a bond with a higher coupon rate than the market will sell at a premium because it pays more interest than newly issued bonds.

Using the provided information, we can interpret a scenario where an investor buys a bond with a face value of $1,000 and a coupon rate of 8%. If market interest rates rise to 12%, the bond's price will drop below the face value, so the yield, which includes interest payments and capital gains, equals the market rate. If there's only one year left to maturity, the selling price would need to be lower to achieve a yield of 12% for the buyer.