Question

Consider a coupon bond with two years left to maturity. It has a face value of $1000 and a coupon rate of 6%. Assume that all investors believe that the first coupon, to be received one year from today, will be paid but that there is only a 60% probability that the second coupon and the principal will be paid two years from today. There is a 40% chance that the investor will receive only $700 at the end of the second period. If the price of this bond is $811.57, what is the expected annual rate of return on the bond? What is the yield to maturity?

Answer 1

1. EXPECTED ANNUAL RATE OS RETURN=COUPON RATE/PRICE OF THE BOND

                                                                         =60/811.57*100

                                                                         =7.39%

                         COUPON PAYMENT+FACE VALUE-PRICE OF THE BOND

      2. YTM=                                   NO. OF.YEARS                                             

                                 FACE VALUE + PRICE OF THE BOND                              

                                                     2

                 = ((60+1000-811.57)/2)/(1811.57/2)*100

                 = 13.71%