Yield to Call. Six years ago the Singleton Company issued 20-year bonds with a 14% annual coupon rate at their $1,000 par value. The bonds had a 9% 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 held them until they were called. Explain why the investor should or should not be happy that Singleton called them.

Answer:

To calculate the realized yield, we use the conventional bondvaluation formula but account for the 9% call premium by changingthe 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 theissuer, that is, when the price of a callable bond reaches the cal lprice.