(This problem illustrates the impact of a call feature. Review the material in the previous chapter, if necessary.) In 2005, a brokerage firm offered a tax-exempt 4.5 percent Ocean City, New Jersey, bond that was due in 11 years for a price of $105.30 with a yield to maturity of 3.89 percent. The bond was callable as follows:

4 years at $101.00 5 years at $100.50 6 and all subsequent years at $100.00.

The call feature is exercisable at the end of each year.

As of the day of offer, the structure of yields on comparable debt was as follows:

Years to Maturity Yield 4 2.35%

5 2.65%

6 3.07%

7 3.18%

Does the callable bond produce a higher or lower return than the comparable bonds?

To answer the question, determine the potential return (yield) on the callable bond for each of the call dates. What is an important implication of your results?

Problems 10 through 13 illustrate factors that may affect Ginnie Maes. The first

(problem 10) covers the determination of the mortgage schedule, that is, the payments received by a Ginnie Mae. The next three problems illustrate how the life of a Ginnie Mae may be affected by refinancing and the possible impact on the bond’s valuation.

Problem 11 considers refinancing, which reduces the number of years a mortgage is outstanding. Problem 12 illustrates valuation based on different assumptions concerning the expected life of the pool. Problem 13 illustrates the potential interest savings to the homeowner by periodically retiring the mortgage faster.