A 10% coupon bond maturing in 10 years that requires annual payments is expected to make all coupon payments but to pay only 50% of par value at maturity.What is the expected yield on this bond if the bond is purchased for $975?

Question

Quizplus · Accepted Answer

To solve for the expected yield, we need to find the bond's present value using the given information. The annual coupon payment is 10% of the par value, or $100. The bond matures in 10 years, so there will be 10 coupon payments of $100 each. The final payment at maturity will be 50% of the par value, or $500.

Using a financial calculator or spreadsheet, we can find that the present value of these cash flows is $963.66. Since the bond is purchased for $975, we have a premium of $11.34.

To find the expected yield, we can use the following formula: 
Expected Yield = (Annual Coupon Payment + (Par Value - Purchase Price) / Years to Maturity) / Purchase Price

Plugging in the values, we get: 
Expected Yield = (100 + (500 - 975) / 10) / 975 = 0.0668 or 6.68%

Therefore, the best choice is B.

A 10% Coupon Bond Maturing in 10 Years That Requires