Google Answers Logo
View Question
Q: Bonds and yield to maturity ( Answered 5 out of 5 stars,   0 Comments )
Subject: Bonds and yield to maturity
Category: Business and Money > Finance
Asked by: mammabear-ga
List Price: $20.00
Posted: 03 Dec 2005 07:00 PST
Expires: 02 Jan 2006 07:00 PST
Question ID: 600872
I am in the midst of taking an online Finance class.  Although I have
read the text in Finance book I cannot find the answer to this
question.  I do not just want the answer.  I need to know where I can
find the information to this answer.

Other things equal, will the following provisions increase or decrease
the yield to maturity at which a firm can issue a bond?
a.) Call provision
b.) A restriction on further borrowing?
c.) A provision of specific collateral for the bond?
d.) An option to convert the bonds into shares?

Thank you for your help!
Subject: Re: Bonds and yield to maturity
Answered By: livioflores-ga on 03 Dec 2005 14:52 PST
Rated:5 out of 5 stars

The first thing you need to know is what are you talking about, that
is a key definition is needed to answer this question:
Yield to Maturity:
"A rate of return measuring the total performance of a bond (coupon
payments as well as capital gain or loss) from the time of purchase
until maturity."
"Yield to Maturity (YTM) - Definition":

The calculation of YTM takes into account the current market price,
par value, coupon rate and time to maturity, and it is also assumed
that all coupons are reinvested at the same rate. See also "Bond Yield
to Maturity (YTM) Formula":

So, at the moment in which a bond is issued all of its future payouts
are determined. The issuer defines the variables and with that it is
determining the YTM, which results being the rate of return offered to
the investors.
As in all investments lower rates are accepted for low risk investment
and viceversa high rates are needed to make attractive a high risk
investment. So what do you need to find is how the different
provisions affect the possibility to get more return on investment to
the bond holders, and with this you can determine if a higher or lower
YTM is needed in the offer.

a.) Call provision:

Call provision is a clause in the written agreement between the bond
issuer and the bondholder granting the issuer the right to buy back
all or part of an issue prior to the maturity date.
Buying a callable bond the buyer of the bond is giving up something:
under certain conditions, the right to hold the bond until its
maturity is not exclusive of the bond holder, the issuer have the
right to redeeem the bonds if the market rate or other variables make
this option advantageous for its interests. With this action wealth
will transferred from the bondholders to the shareholders. Thus, the
buyer is only willing to pay less for the callable bonds.
"A bond call will typically occur when market rates have fallen to a
level where refunding the bond issue will be profitable to the issuer.
Because call provisions subject investors to reinvestment risk,
callable bonds will carry higher yields than non-callable bonds, all
else being equal."
From "BOND CALL - Definition":

See also:
"callable bond Definition":
"...A company will often call a bond if it is paying a higher coupon
than the current market interest rates. Basically, the company can
reissue the same bonds at a lower interest rate, saving them some
amount on all the coupon payments..."

As you can see call provision gives the bond issuer a valuable option
to save money, but this money is taken from the bond holders' future
gains. The investors will require a compensation to buy this kind of


b.) A restriction on further borrowing:
A bond issued with this provision is a Bond Covenant:
"... A covenant whereby the issuer is affirmatively obligated to
undertake a duty in order to protect the interests of bondholders
(e.g., to maintain insurance) is called a ?protective covenant.? ..."  

Covenants are designed to protect the interests of the bondholders,
and in this particular case, this provision is clearly a protective
one that gives more security to the holders and restrict the issuer's
The issuer is giving a plus with the bond: it restrict its actions in
order to give the investors more security lowering the risk of the
bonds, then this bonds will require lower YTM.

See also:
"Bond Covenants":

See the section '9.6 Working in Contractual Relationships'

"Session 6: Bond and Other Long Term Finance":
See the section 'Trust Deeds and Covenants'.


c.) A provision of specific collateral for the bond:

Now we are talking about a Secured Bond:
"Bond backed by collateral, such as a mortgage or lien, the title to
which would be transferred to the bondholders in the event of default.
The most common form of secured bonds are mortgage bonds. These bonds
are backed by real estate or physical equipment that can be
liquidated. These are thought to be high-grade, safe investments.
Other bonds are secured by the revenues created by projects. If an
issuer in default has both secured and unsecured bonds outstanding,
secured bondholders are paid off first, then unsecured bondholders.
Naturally, because unsecured bonds carry greater risk than secured
bonds, they usually pay higher yields."
From "secured bond Definition":

See also:
"Secured Bond:
A type of bond that is secured by the issuer's pledge of a specific
asset, which is a form of collateral on the loan. In the event of a
default, the bond issuer passes title of the asset or the money that
has been set aside onto the bondholders. Secured bonds can also be
secured with a revenue stream that comes from the project that the
bond issue was used to finance.
Because of the pledge of an asset, secured bonds are seen as less
risky than unsecured bonds, and they generally provide lower returns
than unsecured bonds. Securing a bond with the pledge of an asset is
also a way for the bond issuer to lower its interest payments. This
means that secured bonds provide investors with a lower return than
unsecured bonds because even in the event of default, investors will
be compensated at least somewhat for their investment. Some types of
secured bonds are mortgage bonds and equipment trust certificates."
From "Secured Bond":

Since this type of bonds have lower risk than unsecured bonds, they
will require lower YTM.

For further reading see:
"Bonds: Secured Vs. Unsecured":


d.) An option to convert the bonds into shares:

Bonds giving an option to convert the them into shares provide a
substantial additional profit opportunity for investors.
These bonds are Convertible Bonds:
"A corporate bond, usually a junior debenture, that can be exchanged,
at the option of the holder, for a specific number of shares of the
company's preferred stock or common stock...
...convertible bonds tend to have lower interest rates than
non-convertibles because they also accrue value as the price of the
underlying stock rises. In this way, convertible bonds offer some of
the benefits of both stocks and bonds..."
From "convertible bond Definition":

See also "Money Digest: Convertible bonds - Fixed Income Investing":
"Convertible bonds are like other bonds except for one special
feature: they give you the privilege of exchanging the bonds for a
specified number of shares of the company before a certain date.
Because of this attractive feature, the interest rate on convertibles
is usually lower..."

You can say that these bonds are "callable by the holders", and since
the bonds callable by the issuer gives them a valuable option to save
money, these ones gives this option to the holders lowering the risk
of the bonds and they will therefore require a lower YTM.

More info here:
"Should You Buy Convertible Bonds?":


For further reading I suggest you the following articles and documents:

"Bonds and their valuation" (PowerPoint presentation):

"An Investor's Guide to Corporate Bonds" (PDF file):

"What Are Bonds?":
Continue the reading with the links at the left frame menu.

"Financial Pipeline Bond Page":

"Introduction To Bonds - InvestorGuide University":
Continue the reading with the links at the right frame menu.


-Search strategy-
At I used to search the following keywords:
calculation "yield to maturity"
bond definition "yield to maturity"
callable bonds
callable bonds risk
covenant bond
covenant risk bond
secured bonds risk
convertible bonds
convertible bonds "yield to maturity"

I hope that this heps you. Feel free to use the clarification feature
if you need it before rate this anser.

mammabear-ga rated this answer:5 out of 5 stars and gave an additional tip of: $5.00
Thank you so much.  The links are so much more helpful.

There are no comments at this time.

Important Disclaimer: Answers and comments provided on Google Answers are general information, and are not intended to substitute for informed professional medical, psychiatric, psychological, tax, legal, investment, accounting, or other professional advice. Google does not endorse, and expressly disclaims liability for any product, manufacturer, distributor, service or service provider mentioned or any opinion expressed in answers or comments. Please read carefully the Google Answers Terms of Service.

If you feel that you have found inappropriate content, please let us know by emailing us at with the question ID listed above. Thank you.
Search Google Answers for
Google Answers  

Google Home - Answers FAQ - Terms of Service - Privacy Policy