A 10-year, 8% semi-annual fixed coupon callable bond can be called after 5 years from issuance at a call price of 101. 2 years after its issuance, the price of the bond has dropped to 97 per 100 par. Calculate the yield-to-call at this point.
Sample Solution
Answer: The yield-to-call, also known as YTC, is the rate of return that investors can expect to receive if they buy a callable bond and it gets called prior to maturity. To calculate the YTC at this point in time, we need to first determine the present value of all cash flows that will occur up until 5 years from issuance (when the bond could be called). This includes coupon payments, principal repayment upon call date and any capital gains or losses due to changes in market interest rates.
Sample Solution
Answer: The yield-to-call, also known as YTC, is the rate of return that investors can expect to receive if they buy a callable bond and it gets called prior to maturity. To calculate the YTC at this point in time, we need to first determine the present value of all cash flows that will occur up until 5 years from issuance (when the bond could be called). This includes coupon payments, principal repayment upon call date and any capital gains or losses due to changes in market interest rates.
We begin by calculating the present value of each future cash flow associated with this bond. For example, for each semi-annual coupon payment occurring over five years would have an adjusted discount rate of 4% (=8%/2) and therefore generate a present value $95.46 per 100 par [(100*0.08)/(1+0.04)^n], where n=number of periods till cash flow occurs (e.g., 10 semi-annual payments = 20 periods). Additionally, there is also a principal repayment amount at 5th year which has an adjusted discount rate of 0%, resulting in a present value $101 per 100 par [(100*1)/(1+0)^n] since 1/1 = 1 for any number raised by power 0 . Then finally ,the capital gain/loss on initial investment due change market interest rates needs taken account calculate current price which 97 per 100 par thus PV of these two factors add together comes out be 845 92 .
Now ,we can use this information along with price paid initially i e 97 per 100 par compute yield call using following formula : Yield Call = ((Coupons + Principal Repayment )-(Price Paid))/(Price Paid*Number Years Till Maturity ),where Coupons = 95 46 ; Principal Repayment 101 ; Price Paid 97 ; Number Years Till Maturity 5 ie Yield Call = ((95 46 + 101)-97)/(97*5)=3 87 % . Therefore calculated yield call this particular semi annual fixed coupon callable bond 3 87 %
