Fly-By-Night Inc. issues $100 face value, zero-coupon, one-year bonds. The current return on one-year, zero-coupon U.S. government bonds is 3.5%. If the Fly-By-Night bonds are selling for $92.00, what is the risk premium for these bonds?

Question

Quizplus · Accepted Answer

The formula to calculate the yield to maturity (YTM) of zero-coupon bonds is:
YTM = (Face Value / Current Price)^(1/n)-1
Where n is the number of years to maturity.
Applying this formula, we get:
YTM = (100/92)^(1/1)-1 = 8.70%
The risk premium is the difference between the YTM of Fly-By-Night bonds and the current return of one-year, zero-coupon U.S. government bonds. Therefore, the risk premium is:
Risk premium = YTM of Fly-By-Night bonds - Current return on one-year, zero-coupon U.S. government bonds
Risk premium = 8.70% - 3.5% = 5.2%
Therefore, the answer is C, 5.2%.