Yield to call, Financial Management

Assignment Help:

Yield to call is the yield that would be realized on a callable bond assuming the issuer of the bond redeems it before maturity. A bond's call provision is detailed in the bond indenture. Call dates and call prices are specified in the call schedule. Generally, investors calculate yield to first call and yield to first par call.

Calculation of yield to call is similar to the procedure for calculating yield to maturity except for the bond's call date is taken as the maturity date for the former. Yield to call is calculated by determining the interest rate that would make the present value of the expected cash flows, equal to the market price plus the accrued interest. In case of yield to first par call, the expected cash flows would be the interest payments received up to the first date on which the issuer can call the bond at par. The assumptions made here are:

  • The investor will hold the bond to the assumed call date, and

  • The issuer will call the bond on that date.

For example, assume a Rs.100 rupee par value, 7% 5-year bond is selling for Rs. 104.69 and the first call date is 4 years from now and the call price is Rs.101.50. The bond gives semiannual interest. If the bond is called after 4 years, then the cash flow will be like this:

Table 1: Showing Cash Flows in Different Years

Year

Receipt

Total Receipt in the Year

1st year

Two coupons of Rs.3.50 each

Rs.7

2nd year

Two coupons of Rs.3.50 each

Rs.7

3rd year

Two coupons of Rs.3.50 each

Rs.7

4th year

Two coupons of Rs.3.50 each + call price Rs.101.50

Rs.108.50

The present value for interest rates is shown in table 2. It is very clear from the table that 6% annual rate makes the present value of the cash flow equal to the price of Rs.104.69. So, 6% is the yield to first call.

Table 2

Annual Interest Rate (%)

Semiannual Interest Rate (%)

Summated PVs of 8 cash flows of Rs.3.50 each (Rs.)

PV of Rs.101.50  (Rs.)

PV of Total Cash Flow (Rs.)

   5.60

    2.80

           24.78

   81.38

106.16

   5.70

    2.85

           24.73

   81.06

105.79

   5.90

    2.95

           24.62

   80.44

105.06

   6.00

    3.00

           24.57

   80.13

104.69

Now, we will see the calculation of yield to first par call. Assume that, for the bond given above, the first par call date is 6 years from now. In this case, the cash flow will be like this:

Table 3: Showing Cash Flows in Different Year

Year

Receipt

Total Receipt in the Year

Rs.

1st year

Two coupons of Rs.3.50 each

7

2nd year

Two coupons of Rs.3.50 each

7

3rd year

Two coupons of Rs.3.50 each

7

4th year

Two coupons of Rs.3.50 each

7

5th year

Two coupons of Rs.3.50 each

7

6th year

Two coupons of Rs.3.50 each + Rs.100.00

107

The present value for interest rates is shown in table 4. It is very clear from the table that 6.058% annual rate makes the present value of the cash flow equal to Rs.104.69 (only 1 paisa difference). So 6.058% is the yield to first par call.

Table 4

Annual Interest Rate (%)

Semiannual Interest Rate (%)

PV of 12 Payments of Rs.3.50

PV of Rs.100.00, 12 Period from Now

PV of Cash Flow

6.005

3.00

34.83

70.12

104.95

6.018

3.01

34.82

70.06

104.88

6.038

3.02

34.80

69.98

104.78

6.058

3.03

34.78

69.90

104.68                              

Yield to call can be calculated by using the general formula, as given below, if the coupon payment is made semiannually.

          1958_yield to call.png                            

Where,

         PM     =       Present market value.

         NC     =       Number of years to call date (time).

         PC      =       Call price.

         In       =       Interest during the nth period.

         i         =       Discount rate or call rate.


Related Discussions:- Yield to call

Rationale for mergers-product advantages, Product Advantages: A firm th...

Product Advantages: A firm that has developed a reputation for superior products in the domestic market may find acceptance from the foreign consumers as well. Hence, such firm

Duration and convexity of mortgage backed security, Duration an...

Duration and Convexity of MBS A graph decpicting the price of the security under study and the interest rates helps in assessing the duratio

You are required to prepare an income statement, This is an individual assi...

This is an individual assignment.  You are employed as a Trainee Accountant by Finners Accountants Ltd. The Finance Manager, Mr B Proudfoot has asked you to review details from

Project, AThe project is expected to have an initial outlay of $200million ...

AThe project is expected to have an initial outlay of $200million and generate cash inflows of $64million for the next 12 yearssk question #Minimum 100 words accepted#

Premium, The amount by which the market price exceeds the conversion ...

The amount by which the market price exceeds the conversion value or the investment value called the premium. When expressed as a percentage, it is given by,

Transfer price, The price charged when one segment of an organization provi...

The price charged when one segment of an organization provides goods or services to another segment of the organization.

Regular payback period, The director of capital budgeting for a firm has re...

The director of capital budgeting for a firm has recognized two mutually exclusive projects, A and B, with the following expected net cash flows:

What do you mean by variable working capital, Q. What do you mean by Variab...

Q. What do you mean by Variable working capital? Permanent or fixed: Permanent or fixed working capital is the minimum amount which is required to ensure effective utilization

FDD , fimnancial accounting system

fimnancial accounting system

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd