Question

Lloyd Corporation’s 14% coupon rate, semiannual payment , $1000 par value bonds, which mature in 30 years, are callable 5 years from today at $1,050. They sell at a price of $1,353.54 and the yield curve is flat. Assume that interest rates are expected to remain at their current level.

What is the best estimate of these bonds? Remaining Life?

Answer 1

Assuming interest rates remain constant, the best estimate of these bonds' remaining life is 25 years.

Step-by-step explanation:

Since the bonds can be called by Lloyd Corporation in 5 years, their actual remaining life depends on whether that happens. We need to analyze both scenarios:

Scenario 1: Early call at 5 years:

Lloyd would pay $1,050 per bond, resulting in a yield to call of 14% (coupon rate).

This yield is likely higher than what an investor could get elsewhere in the flat interest rate environment.

Therefore, it's highly likely Lloyd will call the bonds at 5 years.

Scenario 2: No early call and maturity at 30 years:

The bond price ($1,353.54) already reflects the discounted future value of all remaining coupon payments and the par value at maturity.

Analyzing this complex price with discounting methods would reveal an "effective maturity" shorter than 30 years. However, estimating its precise value is beyond the scope of this limited response.

Conclusion:

Based on the high call probability and the flat interest rate environment, the most likely scenario is an early call at 5 years. Therefore, the best estimate for the bonds' remaining life is 25 years (30 years total maturity minus 5 years of potential early call).

Answer 2

The remaining life of the bond is 25 years.

Step-by-step explanation:

The best estimate for the remaining life of the bond can be calculated by considering the time until the bond is callable. In this case, the bonds are callable 5 years from today and have a maturity of 30 years. Therefore, the remaining life of the bond is 30 years - 5 years = 25 years.