Yield to call, Financial Management

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.

Posted Date: 9/10/2012 1:54:32 AM | Location : United States







Related Discussions:- Yield to call, Assignment Help, Ask Question on Yield to call, Get Answer, Expert's Help, Yield to call Discussions

Write discussion on Yield to call
Your posts are moderated
Related Questions

Q. What is Affiliated Company? Affiliated Company - Company or other organization related through common ownership,common control of management or owners or through some other

What are the objectives of working capital management? Briefly explain the various elements of operating cycle.

Interlinkage in the Financial Markets - Common Features The interlinkage present in the financial markets is essentially due to the fact that all these markets are in the proce

What is the difference between economic profit and producer surplus? When economic profit is the difference among total revenue and total cost, producer surplus is the variatio

QUESTION 1 (a) What are the differences between futures and forwards? (b) Clearly explain the following position on options i) Going long on a call option ii) Going lo

Does high operating leverage always mean high business risk?  Explain. High operating leverage does not all the time mean high business risk.  If the companies sales are quite

Reinvestment risk is the risk involved in reinvesting the proceeds received from the issuer against callable bonds. During falling interest rate periods, investor canno

Investment Objectives: Any investment should always start with identifying its objective. Thus, the first step in the pension fund investment management system is defining the

The Chinese Pension Fund System Mainland China has a rapidly aging population. This is attributable to two main factors - the one-child policy plus substantial improvements in l