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

Define which is lower cost of debt or cost of equity, Which is lower for a ...

Which is lower for a given company:  the cost of debt or the cost of equity?  Explain: Ignore taxes in your answer . The cost of debt is all the time less as compared to the cost

Principle of leverage, Leveraging can be described as an investing pr...

Leveraging can be described as an investing principle where funds are borrowed to invest in a part of the securities. The manager hopes to earn a return that is g

Which ratios would a banker be most interested, Which ratios would a banker...

Which ratios would a banker be most interested in when considering whether to approve an application for a short-term business loan? Explain. Bankers and other lenders use liq

Calculate roe when roe may be calculated more simply, Why would an analyst ...

Why would an analyst use the Modified Du Pont system to calculate ROE when ROE may be calculated more simply? Explain. In fact, an analyst wouldn't use the Modified Du Pont eq

Step-up (step down) notes, These types of securities have more ...

These types of securities have more than one coupon rate and each subsequent coupon rate is higher (or lower) than the previous coupon rate. For

Ratio analysis, define ratio analysis. explain the advantages of ratio anal...

define ratio analysis. explain the advantages of ratio analysis

State the several goals for the organisation, State the several goals for t...

State the several goals for the organisation As there could be several goals for the organisation, we must try and summarise theorganisational goals in financial terms so that

Cash flow statements, Cash flow statement: The cash flow statement summ...

Cash flow statement: The cash flow statement summarises the flow of cash into and out of the business over a certain period of time. The cash flow statement measures the liq

Show the present value of a single flow, Q. Show the Present Value of a Sin...

Q. Show the Present Value of a Single Flow ? Discounting or else Present Value of a Single Flow (Lump Sum):- We are able to determine the PV of a future cash flow using the for

Different types of cash flow to bondholder of coupon bonds, What are the di...

What are the different types of cash flow to the bondholder of coupon bonds? Coupon bonds deliver two different kinds of cash flow to the bondholder are as follows: a. Face

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