A corporate bond has one-year maturity. The bond pays an interest of $50 and principal of
$1,000 at maturity. If the bond has 10% probability of default and payment under default is
$400, and an investor buys the bond for $890.19; Calculate the promised yield on the bond.

Question

Quizplus · Accepted Answer

The promised yield is calculated using the formula for yield to maturity (YTM), considering the bond's cash flows and purchase price. The bond pays $1,050 if it doesn't default and $400 if it defaults. The expected cash flow is $1,050 * 0.9 + $400 * 0.1 = $985. The promised yield is the rate that equates the present value of expected cash flows to the purchase price: $890.19 = $985 / (1 + YTM). Solving for YTM gives approximately 17.95%.

A Corporate Bond Has One-Year Maturity