The promised yield on a non-interest-bearing security with one year to maturity,a face value of $100,a 20% chance of default and an expected market rate of return of 10%,is:
A)7.8%.
B)37.5%.
C)25%.
D)10%.

Question

Quizplus · Accepted Answer

The promised yield is calculated by considering the probability of default and the expected return. With a 20% chance of default, the expected payoff is 80% of $100, which is $80. The yield is then calculated as ($80 - $100) / $100 = -20%. However, to achieve an expected market rate of return of 10%, the promised yield must be higher to compensate for the default risk. Solving for the promised yield, we find it to be approximately 37.5%.

The Promised Yield on a Non-Interest-Bearing Security with One Year