Final answer:
The yield to call of a bond is the annualized return considering the bond's callable feature, depending on the call price and time to call. Variables like coupon payments, call price, and market price of the bond are key components in calculating the YTC, which can change if any of these variables are adjusted.
Step-by-step explanation:
When computing the yield to call (YTC) of a bond, the goal is to determine the annualized return assuming the bond will be called at the soonest possible date at the call price. YTC calculations use the current bond price, the call price, the coupon payments until the call date, and the time until the bond can be called.
To calculate the YTC, we first need to determine the total cash flows an investor will receive until the bond is callable and then find the interest rate that equates those cash flows to the current price of the bond. The calculation is similar to finding the yield to maturity (YTM), but the time frame is until the call date rather than full maturity.
a. For the bond callable at $1,010 in five years, we would calculate the present value of the semiannual coupon payments and the call price, adjusting for the bond's current market price to find the YTC.
b. If the bond's call price is lowered to $960, the investor will receive a smaller final payment upon calling, which impacts the yield calculation, meaning the yield will typically rise as the call price is lower.
c. If the bond can be called in two years with a call price of $1,010, the time frame for receiving coupon payments is shorter and the overall return period is less, hence the yield will usually be different than when the bond is callable in five years. This emphasizes the importance of the time to call in the yield calculation.