Does a callable bond benefit the issuer of a bond or the purchaser? Would the price of
Question:
Does a callable bond benefit the issuer of a bond or the purchaser? Would the price of a callable bond be higher or lower than a non-callable bond, all else being equal? (3 marks)
b. Does a convertible bond benefit the issuer of a bond or the purchaser? Would the price of a convertible bond be higher or lower than a non-convertible bond, all else being equal? (3 marks)
c. Given your answers to parts a and b, check to see whether the prices in the following table are consistent.
You will analyze the following three bonds, which are identical except for the special features listed. (8 marks total)
Bond | Face value | Maturity | Coupon rate (paid annually) | Yield to maturity* | Special features | Price |
a | 1000 | 20 years | 5.5% | 5% | None | 1062.31 |
b | 1000 | 20 years | 5.5% | 5.5% | Callable | 1000.00 |
c | 1000 | 20 years | 5.5% | 3.5% | Callable and Convertible into stock | 1284.25 |
Yield to maturity represents the market's required rate of return. It is calculated using only the price, the stated coupon payments, and face value, without regard for the special features.
i. What is the implied value of the callability provision? (2 marks)
ii. Is this value consistent with your answer to part a? Briefly explain. (2 marks)
iii. What is the implied value of the conversion privilege? (2 marks)
iv. Is this value consistent with your answer to part b? Briefly explain. (2 marks)