A two-year bond with par value $1,000 making annual coupon payments of $99 is priced at $1,000. a. What is the yield to maturity of the bond? (Round your answer to 1 decimal place.)

b. What will be the realized compound yield to maturity if the one-year interest rate next year turns out to be (a) 7.9%, (b) 9.9%, (c) 11.9%? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

(a) 9.9%

(b)  10.09%

The further explanation is given below.

Explanation:

The given values are:

Coupon payment

=  $99

Price

=  $1,000

(a)

The Yield to maturity (YTM) will be:

=

where,

C = Coupon payment

P = Price

n = years to maturity

F = Face value

On putting the estimated values is the above formula, we get

⇒  

⇒  

⇒  %

(b)

Although the 1st year coupon was indeed reinvested outside an interest rate of r%, cumulative money raised will indeed be made at the end of 2nd year.  

=

Came to the realization compound YTM is therefore a function of r, as is shown throughout the table below:

Rate (r)            Total proceeds         Realized YTM ()

7.9%                      1205.8                                   9.8%

9.9%                             1207.8                                   9.9%

11.9%                      1209.8                                  9.99%

Now,

Overall proceeds realized YTM:

=

=

=

=

=

=

= %

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