A 5-year 6% annual coupon bond yields 4%. The bond is callable in one year at 102. What is the yield to call? Solve the problem in three stages.

Draw the picture of the bonds cash flows assuming it will be called in one year.

Compute the internal rate of return on the cash flows ie. solve for y

$Coup + $Call Prc P₀ = ------------------------ y = .. % 1 + y

Draw the picture of the bonds cash flows assuming it will be called in two years.

If the bond is callable in two years, the yield to call is:

$ Coup $Coup + $CallPrc P₀ = ------------ + ---------------------- y = .. % 1 + y (1 + y)²