A zero-coupon bond has a beta of 0.15 and promises to pay $5,000 next year with a probability of 96%, $1,000 with a probability of 2%, and there is a 2% probability of total default. One-year Treasury securities are yielding 4%, and the expected return on the market is 10%.
-Refer to the information above. What is the promised rate of return on this bond investment? Round your answer to the nearest tenth of a percent.

Question

Quizplus · Accepted Answer

The promised rate of return on the bond investment can be calculated by finding the expected payment and then determining the rate of return based on the current price of the bond. The expected payment is calculated as follows: (0.96 * $5,000) + (0.02 * $1,000) + (0.02 * $0) = $4,820. The bond promises to pay this amount in one year. To find the promised rate of return, we compare this to the initial investment required to receive the $4,820. Assuming the bond is priced at par ($5,000), the calculation for the rate of return would be incorrect since we don't have the bond's current price. However, the correct approach to find the promised rate of return involves calculating the expected return based on the probabilities and outcomes given, which leads to the expected payment calculation. Given the lack of bond price information, we directly use the expected payment to infer the promised rate of return, which is not directly calculable with the information provided. The correct answer, based on the expected payment and typical bond return calculations, would involve comparing the expected payment to the bond's current price, but since we only have the expected payment and not the bond's price or the method to directly calculate the return, the explanation involves understanding that the promised rate of return reflects the expected payment relative to the bond's cost. The calculation provided aims to show the expected outcome, but without the bond's purchase price, we cannot directly calculate the return. The answer choice A (8.8%) is selected based on the assumption that the question intended to ask for the expected payment calculation, which was misunderstood in the explanation.

A Zero-Coupon Bond Has a Beta of 0