I appreciate this forum mostly deals with bond futures but I have an interest in buying corporate bonds for income generation. Maybe not now since interest rates will go up but I'm currently just trying to understand them. I partuclary have a question about this bond.
If I've got this correctly I will pay 172.242 for something that is worth a 100 dollars. I understand this pays well but still it seems awfully lofty to pay this price for this bond. The bond syas it not callable but there's this make whole call per another web site
07/11/1997 Asset Make Whole Call: Redeemable at any time at a price the greater of (i) 100% of principal amount or (ii) the sum of the present values of the remaining scheduled payments of principal and interest discounted to the redemption date on a semiannual basis (30/360 day count) at the comparable maturity Treasury rate plus 10 basic points plus accrued interest.
07/16/1997 CUSIP Bureau Description TRANCHE # TR 00002 DTD 11/05/96 7.250% 11/02/2096
Per this statement, it seems like they could call this at anytime and you wouldn't be able to receive what you paid into today at current pricing. What am I missing?
The link did not get me any further. However, you have cited
"Asset Make Whole Call: Redeemable at any time at a price the greater of (i) 100% of principal amount or (ii) the sum of the present values of the remaining scheduled payments of principal and interest discounted to the redemption date on a semiannual basis (30/360 day count) at the comparable maturity Treasury rate plus 10 basic points plus accrued interest."
This would mean that if the bond was called today, you would need to discount the remaining scheduled payments of principal and interest at the specified rate. That would leave you with two tasks
(1) calculate the specified rate R
(2) then apply that rate to the remaining cash flow
It is no fun to calculate that rate and it is no fun to discount the cash flow.
So I will just make a few remarks: I would have difficulties finding the comparable treasury rate, as that bond still runs 84 years to expiry. The maximum maturity of US Treasury Bonds is 30 years. That means that the yield curve ends in 30 years. Now you would have two option
-> either you extend the yield curve
-> or you convince the Treasury to issue a new bond with a maturity of 84 years
As a first approximation you can convert the current quotes for ultra-bond futures to the yield, and then add something. You would then need to add the 10 basis points as specified above.
Once you know the rate, it is relatively easy to discount the remaining cash flow of the bond and calculate the present value.
There is no redemption risk, but a significant market risk
If the bond could be redeemed at a significantly lower price then its current quote, this would represent an arbitrage opportunity for the issuer, who would be able to issue a new bond at the yield implied by the current bond and at the same time repurchase the old bonds at a lower rate. I think that you do not have to worry about this case.
However, there is something else you should worry about. This is current structure of the bond market. The current yield of a 30-year bond (per today) is 2.55%. This is the lowest yield of the last 35 years.
If you buy that bond, you basically lock in that low yield for the next 84 years. And on top of that you get a significant counterparty risk. So the risk you are running is not a redemption risk, but the market risk that long term rates will move up again.
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Treasury yields since 1977 (source: Yahoo Finance).
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