A bond has a par value of $1,000, a time to maturity of 20 years, a coupon rate of 10% with interest paid annually, a current price of $850, and a yield to maturity of 12%.Intuitively and without using calculations, if interest payments are reinvested at 10%, the realized compound yield on this bond must be

Question

Quizplus · Accepted Answer

Since the coupon rate is 10% and the current price is below par ($1,000), the yield to maturity must be higher than the coupon rate. Therefore, it makes sense that the realized compound yield would be higher than 10%. The yield to maturity of 12% tells us the average annual yield over the 20-year life of the bond, assuming interest payments are not reinvested. However, since interest payments are reinvested at 10%, the realized compound yield would be higher than the yield to maturity of 12%. The correct answer is closest to 10.9%, which is a reasonable estimate for the realized compound yield. Therefore, the best choice is B.

A Bond Has a Par Value of $1,000, a Time