Orange District Hospital issued a 30-year, 10 percent annual coupon bond (par value $1,000) two years ago. The bond now has 28 years remaining to maturity and sells for $1,400. The bond has a call provision that allows the hospital to call the bond in ten years at a call price of $1,100. If an investor expects a call and requires a 6.5% rate of return, will the investor be likely to purchase the bond? Explain your answer with calculations.
Orange District Hospital issued a 30-year, 10 percent annual coupon bond (par value $1,000) two years ago. The bond now has 28 years remaining to maturity and sells for $1,400. The bond has a call provision that allows the hospital to call the bond in ten years at a call price of $1,100. If an investor expects a call and requires a 6.5% rate of return, will the investor be likely to purchase the bond? Explain your answer with calculations.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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![**Orange District Hospital issued a 30-year, 10 percent annual coupon bond (par value $1,000) two years ago. The bond now has 28 years remaining to maturity and sells for $1,400. The bond has a call provision that allows the hospital to call the bond in ten years at a call price of $1,100. If an investor expects a call and requires a 6.5% rate of return, will the investor be likely to purchase the bond? Explain your answer with calculations.**
When evaluating the decision to purchase this bond, we need to compare the yield the bond offers (expected if called) with the investor's required rate of return, which is 6.5%.
### Calculations:
1. **Coupon Payment**:
- The annual coupon payment is 10% of $1,000, which equals $100.
2. **Call Feature**:
- The bond can be called in 10 years at a price of $1,100.
3. **Calculating the Yield to Call (YTC)**:
- To find if the bond meets the required 6.5% return with the call feature, we need to determine if the YTC is at least 6.5%.
- **Formula for approximate YTC**:
\[
\text{YTC} = \frac{\text{Coupon Payment} + \frac{\text{Call Price} - \text{Purchase Price}}{\text{Years to Call}}}{\frac{\text{Call Price} + \text{Purchase Price}}{2}}
\]
- Inserting the known values:
- **Coupon Payment** = $100
- **Call Price** = $1,100
- **Purchase Price** = $1,400
- **Years to Call** = 10
\[
\text{YTC} = \frac{100 + \frac{1,100 - 1,400}{10}}{\frac{1,100 + 1,400}{2}}
\]
\[
\text{YTC} = \frac{100 - 30}{1,250}
\]
\[
\text{YTC} = \frac{70}{1,250} = 0.056 \text{ or } 5.6\%
\]
###](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Fa0bc9ff5-4fd1-4a68-8564-3d0282184e7c%2F1a034efe-f25f-4a09-8e51-9e01d12d66aa%2F7nelgtp_processed.png&w=3840&q=75)
Transcribed Image Text:**Orange District Hospital issued a 30-year, 10 percent annual coupon bond (par value $1,000) two years ago. The bond now has 28 years remaining to maturity and sells for $1,400. The bond has a call provision that allows the hospital to call the bond in ten years at a call price of $1,100. If an investor expects a call and requires a 6.5% rate of return, will the investor be likely to purchase the bond? Explain your answer with calculations.**
When evaluating the decision to purchase this bond, we need to compare the yield the bond offers (expected if called) with the investor's required rate of return, which is 6.5%.
### Calculations:
1. **Coupon Payment**:
- The annual coupon payment is 10% of $1,000, which equals $100.
2. **Call Feature**:
- The bond can be called in 10 years at a price of $1,100.
3. **Calculating the Yield to Call (YTC)**:
- To find if the bond meets the required 6.5% return with the call feature, we need to determine if the YTC is at least 6.5%.
- **Formula for approximate YTC**:
\[
\text{YTC} = \frac{\text{Coupon Payment} + \frac{\text{Call Price} - \text{Purchase Price}}{\text{Years to Call}}}{\frac{\text{Call Price} + \text{Purchase Price}}{2}}
\]
- Inserting the known values:
- **Coupon Payment** = $100
- **Call Price** = $1,100
- **Purchase Price** = $1,400
- **Years to Call** = 10
\[
\text{YTC} = \frac{100 + \frac{1,100 - 1,400}{10}}{\frac{1,100 + 1,400}{2}}
\]
\[
\text{YTC} = \frac{100 - 30}{1,250}
\]
\[
\text{YTC} = \frac{70}{1,250} = 0.056 \text{ or } 5.6\%
\]
###
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