Investments, tenth edition

  

  Yield to Call  

  Yield to Maturity  

 Coupon payment 

 $40  

$40 

 Number of semiannual periods 

 20 periods 

 60 periods 

 Final payment 

 $1,100  

$1,000 

 Price  

$1,150  

$1,150 

 Yield to call is then 6.64%. [To confirm this on a calculator, input  n    5  20; PV  5  

( 2 )1150; FV  5  1100; PMT  5  40; compute  i  as 3.32%, or 6.64% bond equivalent yield.] 

Yield to maturity is 6.82%. [To confirm, input  n    5   60; PV   5   ( 2 )1150; FV   5   1000; 

PMT  5  40; compute  i  as 3.41% or 6.82% bond equivalent yield.] In Excel, you can cal-

culate yield to call as  5  YIELD(DATE(2000,01,01), DATE(2010,01,01), .08, 115, 110, 2). 

Notice that redemption value is input as 110, i.e., 110% of par value. 

 Example  14.5 

Yield to Call 

    a.  The yield to maturity on two 10-year maturity bonds currently is 7%. Each bond has a call price of 

$1,100. One bond has a coupon rate of 6%, the other 8%. Assume for simplicity that bonds are called 

as soon as the present value of their remaining payments exceeds their call price. What will be the 

capital gain on each bond if the market interest rate suddenly falls to 6%?  

   b.  A 20-year maturity 9% coupon bond paying coupons semiannually is callable in 5 years at a call price 

of $1,050. The bond currently sells at a yield to maturity of 8%. What is the yield to call?   

 CONCEPT CHECK 

14.4 

  We have noted that most callable bonds are issued with an initial period of call protec-

tion. In addition, an implicit form of call protection operates for bonds selling at deep dis-

counts from their call prices. Even if interest rates fall a bit, deep-discount bonds still will 

sell below the call price and thus will not be subject to a call. 

 Premium bonds that might be selling near their call prices, however, are especially apt 

to be called if rates fall further. If interest rates fall, a callable premium bond is likely to 

provide a lower return than could be earned on a discount bond whose potential price 

appreciation is not limited by the likelihood of a call. Investors in premium bonds therefore 

may be more interested in the bond’s yield to call than its yield to maturity because it may 

appear to them that the bond will be retired at the call date.