You are considering investing in a zero-coupon bond that will pay you its face value of $1000 in ten years.If the bond is currently selling for $485.20,then the internal rate of return (IRR)for investing in this bond is closest to:
A)12%
B)8.0%
C)7.5%
D)10%

Question

Quizplus · Accepted Answer

To calculate the IRR, we need to solve for the discount rate that makes the present value of the bond's future cash flows equal to its current price. In this case, there is only one cash flow (the face value of $1000) and the current price is $485.20. Using a financial calculator or spreadsheet, we can solve for the discount rate that makes the present value equal to $485.20:

PV = FV / (1 + r)^n
$485.20 = $1000 / (1 + r)^10
(1 + r)^10 = $1000 / $485.20
1 + r = ( $1000 / $485.20 )^(1/10)
r = ( $1000 / $485.20 )^(1/10) - 1
r = 0.07498 or 7.498%

Therefore, the closest answer choice is C) 7.5%.

You Are Considering Investing in a Zero-Coupon Bond That Will