Final answer:
The realized rate of return for an investor who purchased the bonds at their par value and held them until the call would include 7 years of coupon payments and the call premium. This return is potentially lower than the original coupon rate depending on interest rate changes. The investor's satisfaction with the call depends on whether they can reinvest at a higher or lower rate in the current market.
Step-by-step explanation:
To compute the realized rate of return for an investor who purchased the 20-year bonds with an 11% coupon rate at their $1,000 par value and held them until they were called, we need to take into account the call premium and the annual coupon payments. The bonds were called after 7 years, and the investors would have received $1,100 ($1,000 face value plus an additional 7.5% call premium) plus 7 years of coupon payments of $110 per year.
The calculation for the realized rate of return is as follows:
Total coupon payments received over 7 years = 7 x $110 = $770
Total amount received when the bonds were called = $1,000 + $75 (7.5% of $1,000) = $1,075
Total return = $770 (coupons) + $1,075 (call amount) = $1,845
Initial investment = $1,000
Realized rate of return = (($1,845 - $1,000) / $1,000) x 100
The realized rate of return would be less than the coupon rate of 11% due to the difference between the call premium and the coupon payments over the 7 years. If the market interest rates have fallen since the issue, the investor might not be happy about the call because they could be reinvesting the proceeds at a lower interest rate than the bond's coupon rate. However, if the market interest rates have risen, the investor could potentially reinvest at a higher rate, making the call more favorable.