The ABC Corporation issues a 20-year $1000 par value bond with bond interest at j₂ = 6%.The bond is callable as early as the end of 10 year at $1100.The price of the bond to yield j₂ = 5% is
• $1125.51 assuming the bond is held to maturity.
• $1138.97 assuming the bond is called at the end of 10 years.
In which of the following situations would the actual yield rate more than 5%?
(i) An investor pays $1138.97 for the bond and it is held to maturity;
(ii) An investor pays $1125.51 for the bond and it is called at the end of 15 years.

Question

Quizplus · Accepted Answer

For situation (i), the actual yield rate would be equal to the coupon rate of 6% if the bond is held to maturity and the investor paid $1138.97. Therefore, the actual yield rate would be less than 5% and not more than 5%.

For situation (ii), the bond is called at the end of 15 years, which is after the earliest call date of 10 years. Therefore, the actual yield rate would be higher than the yield to maturity of 5% that was used to calculate the price of $1125.51. Hence, the actual yield rate would be more than 5%.

Therefore, the answer is B) (ii) only.

The ABC Corporation Issues a 20-Year $1000 Par Value Bond