Six years ago, Bradford Community Hospital issued 20-year municipal bonds with a 7% annual coupon rate. The bonds were called today for a $70 call premium- that is, bondholders received $1,070 for each bond. What is the realized rate of return for those investors who bought the bonds for $1,000 when they were issued?
7.94%
To calculate the realized rate of return for those investors who bought the bonds, we need to consider the coupon payments received over the holding period as well as the gain or loss from the call premium.
Here's how you can calculate it step by step:
1. Determine the coupon payments received: The bond has a 7% annual coupon rate, and it was issued 6 years ago as a 20-year bond. This means there are 14 more years until maturity. Since it's an annual coupon payment, each year you will receive 7% * $1,000 = $70 as a coupon payment. So, over the 6-year holding period, you will receive 6 * $70 = $420 as coupon payments.
2. Calculate the gain or loss from the call premium: The bond was called today at a call price of $1,070, meaning bondholders received $1,070 for each bond. However, investors initially bought the bond for $1,000. Therefore, the gain from the call premium is $1,070 - $1,000 = $70.
3. Calculate the total amount received: Add the coupon payments received ($420) with the gain from the call premium ($70) to get the total amount received: $420 + $70 = $490.
4. Calculate the realized rate of return: To calculate the realized rate of return, divide the total amount received ($490) by the initial investment ($1,000) and then convert that into a percentage. So, the realized rate of return is (490/1000) * 100% = 49%.
Therefore, the investors who bought the bonds for $1,000 when they were issued realized a rate of return of 49%.