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Masters Corp. issues two bonds with 20-year maturities. Both bonds are callable at $1,050. The first bond is issued at a deep discount with a coupon rate of 4% and a price of $580 to yield 8.4%. The second bond is issued at par value with a coupon rate of 8.75%.

 a. What is the yield to maturity of the par bond? Why is it higher than the yield of the discount bond?

 b. If you expect rates to fall substantially in the next two years, which bond would you prefer to hold?

 c. In what sense does the discount bond offer “implicit call protection”?


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