Can someone please help me with this question?
George Fuller is evaluating a 7%, 10 year bond that is callable at par in 5 years. Coupon payments can be reinvested at an annual rate of 7% and the current price of the bond is $106.50. The bond pays interest semi-annually. Should Fuller consider the YTC or the YTM in making his purchase decision?
A. YTM, since YTM is greater than YTC.
B. YTC, since YTC is less than YTM.
C. YTC, since YTC is greater than YTM.
Whichever is lower.
YTM N = 20, PV = -106.5, PMT = 3.5, FV = 100 --> I/Y = 3.0606 Corresponding annual YTM will be 6.1213.
YTC
N = 10, PV = -106.5, PMT = 3.5, FV = 100 --> I/Y = 2.7478 Corresponding annual YTC will be 5.4956.
So, the lower is YTC.
Correct me if I am wrong with the following explanation, S2000magician. Since the execution of call option is out of the investor’s control, the investor is forced to err on the side of caution and use the lower of YTM and YTC.
Exactly.
The lowest of yield to maturity, yield to call (or yield to first call, yield to second call, etc.), yield to redemption, and so on (all the yields that are out of the bondholder’s control) is called _ yield to worst _ (YTW); that’s what you’re calculating here.
got it guys thanks a lot. Just revised the YTC & YTW concept.
My pleasure.