A company issues a callable (at par)20-year, 5% coupon bond with annual coupon payments. The bond can be called at par in one year after release or any time after that on a coupon payment date. On release, it has a price of $102 per $100 of face value. What is the yield to worst of this bond when it is released?

Question

Quizplus · Accepted Answer

The yield to worst (YTW) for a callable bond is the lowest possible yield the bond can offer, considering all potential call dates. Since the bond can be called at par one year after release, the worst-case scenario for an investor is if the bond is called at the earliest possible date. This would result in the investor receiving only one year of coupon payments plus the principal. The YTW in this case would be the yield that equates the bond's cash flows (one year of interest plus the principal repayment) to its current price. Given the bond's price is $102 and it can be called at $100 (par) plus a $5 coupon payment after one year, the YTW is calculated based on these cash flows. The calculation involves finding the discount rate that equates the present value of these cash flows to the bond's price, which results in a YTW of 2.94%.

A Company Issues a Callable (At Par)20-Year, 5% Coupon Bond