Final answer:
The yield to call of a bond is calculated by comparing the cash flows received (interest payments and call price) to the purchase price of the bond. For the specific example given, the calculation involves determining the total interest received for the period the bond is held, adding the call price to the last interest payment, and annualizing the net gain or loss relative to the purchase price.
Step-by-step explanation:
The student is asking how to determine the yield to call for a bond investment. To calculate the yield to call, we need to consider the cash flows received by the investor and compare them to the purchase price of the bond. The cash flows include the call price plus any remaining interest payments until the call date.
In this case, the investor purchased the bond for $1,020.00 and will receive $1,017.50 when the bond is called, in addition to receiving annual interest payments at a rate of 6.625 percent on the $1,000 par value of the bond for four years. The yield to call is calculated as the internal rate of return on these cash flows.
To calculate the yield to call:
- Calculate total interest received: $1,000 * 0.06625 = $66.25 per year for 4 years.
- Add the call price to the last interest payment: $1,017.50 + $66.25 = $1,083.75.
- Subtract the purchase price from the total cash received: $1,083.75 (call price plus last interest) - $1,020.00 (purchase price).
- Divide the result by the purchase price: ($1,083.75 - $1,020.00) / $1,020.00.
- Divide by the number of years (4) to annualize: [($1,083.75 - $1,020.00) / $1,020.00] / 4.
This result will give the annual yield to call as a percentage. This is just an illustrative example, and the actual yield to call calculation would require more precise financial calculations, including the present value of cash flows.