CFA Level IFixed IncomeMedium
A 10-year, 6% annual-coupon corporate bond is callable in 3 years at a call price of 103% of par. The bond currently trades at 101.00. Using N=3, PMT=6, PV=-101, FV=103, the bond's yield to call (YTC) is closest to:
- A6.57%
- B5.73%
- C6.00%
- D7.20%
Show answer & explanationAnswer & explanation
Correct answer: A. 6.57%
Solving 101 = 6/(1+r) + 6/(1+r)^2 + 109/(1+r)^3 for r gives r ≈ 6.57%. This treats the call date as the bond's effective maturity, with cash flows of the coupon plus the call price at year 3.
Why the other options are wrong
- B. Too low; does not equate the discounted cash flows to the 101 price.
- C. Equals the coupon rate, but price above par at the call price requires a rate above the coupon since the bond is priced below the redemption value relative to cash flows.
- D. Too high; overstates the required discount rate given the cash flows and price.
Yield to Call (YTC)
The annualized return an investor earns if a callable bond is held until its first (or a specified) call date and redeemed at the call price.
- Uses call price as FV and call date as N instead of maturity
- Investors compare YTM and YTC(s) to find yield to worst
- Callable bonds often trade closer to call price when rates fall
Memory trick: 'Call it early, price it early — swap FV and N for the call date'