Why is the yield to maturity of a zero-coupon, risk-free bond that matures at the end of a given period the risk-free interest rate for that period?
A) Since such a bond provides a risk-free return over that period, the Law of One Price guarantees that the risk-free interest rate equals the yield to maturity.
B) Since a bond's price will converge on its face value as the bond approaches the maturity date, the Law of One Price dictates that the risk-free interest rate will reflect this convergence.
C) Since interest rates will rise and fall in response to the movement in bond prices.
D) Since there is, by definition, no risk in investing in such bonds, the return from such bonds is the best that can be expected from any investment over the period.

Question

Quizplus · Accepted Answer

A zero-coupon, risk-free bond's yield to maturity is the risk-free interest rate for the period because it provides a guaranteed return over that period, and according to the Law of One Price, no arbitrage opportunities exist, meaning the yield must equal the risk-free rate.

Why Is the Yield to Maturity of a Zero-Coupon, Risk-Free