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1. Answer(A):
A bond will sell only at par rate when the yield to maturity of the bond equals the coupon rates
=> YTM = Coupon rate => Bond sells/issued at par rate
In this case the second bond is issued at a par with a coupon rate of 8.9%.
Therefore Yield to maturity of the par bond is 8.9% same as coupon rate
Answer(B):
We are given with the fact that the yield is expected to fall over the next 2 years.
=> If Yield of the bond decreases => Price of the bond increases (inversly proportional)
Therefore if the rates fall we can expect to receive a larger income from the discounted bond than the par bond because there is a greater potential of capital gains from it.
We would hold the first bond i.e; discounted bond when the rates fall
Answer(C):
A callable bond means that the firm has a possibility of calling the bond when the price of the bond exceeds call price of the bond. If the yields are to fall in an unlikely event, then the discounted bond increases in price to exceed the call price to make the firm owners to call the bond. Therefore the discounted bonds are said to have an implicit call protection.
2. Answer:
The Yield to maturity will be the same across the both bonds because it does not consider the fact of callable values. Rather it depends on the coupon rates, years to maturity etc. The bonds are equal in every aspect, so YTM is the same for both the bonds.
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