The yield-to-maturity on a default-free, similar bond is 6%. If there is a risk premium of 3% and a default premium of 2% on the bond, the promised yield-to-maturity is
A) 11%.
B) 8%.
C) 4%.
D) 9%.

Question

The yield-to-maturity on a default-free, similar bond is 6%.	If there is a risk premium of 3% and a default premium of 2% on the bond, the promised yield-to-maturity is
A) 11%.
B) 8%.
C) 4%.
D) 9%.

Quizplus · Accepted Answer

The promised yield-to-maturity can be calculated as the sum of risk premium, default premium and the risk-free rate of return. Let the risk-free rate of return be r.
Yield-to-maturity = Risk premium + Default premium + Risk-free rate of return
Yield-to-maturity = 3% + 2% + r
Given, the yield-to-maturity is 6%. Therefore,
6% = 3% + 2% + r
r = 6% - 3% - 2%
r = 1%
Therefore, the promised yield-to-maturity is 1% (risk-free rate) + 3% (risk premium) + 2% (default premium) = 6%. 
So, the correct answer is A) 11%.

The Yield-To-Maturity on a Default-Free, Similar Bond Is 6