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posted by  PollyB on 8/3/2009 12:20:31 PM  |  status: Live  |  Earned Karma: 25

Finance

Course Textbook Chapter Problem Needs by
Finance Fundamental of Financial Management 11th edition Chapter 7 7-8 N/A
Question Details:
Six years ago, the Singleton Company issued 20-year bonds with a 14 percent annual coupon rate at their $1000 par value.  The bonds had a 9 percent call premium, with 5 years of call protection.  Today, Singleton called the bonds.  Compute the realized rate of return for an investor who purchased the bonds when they were issued and help them until they were called.  Explain why the investor should or should not be happy that Singleton called them.
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posted by Domokun on 8/23/2009 6:14:37 PM  |  status: Live
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Response Details:
To calculate the realized yield, we use the conventional bond valuation formula but account for the 9% call premium by changing the maturity value to 1090.

Using the following formula:
Bond Price
1000 = 140 x [1-(1/(1+i)^6] / i + 1090 / (1+i)^6
Solving for i, we get:
i = 0.15
The is the realized rate of return.

The investor should not be happy that the issuer called the bonds, because bonds will only be called when it is favorable to the issuer, that is, when the price of a callable bond reaches the call price.
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