Problem 24-1 Expected yield You own a bond with an annual coupon rate of 5% maturing in two years and priced at 87%. Suppose that there is a 10% chance that at maturity the bond will default and you will receive only 40% of the promised payment. Assume a face value of $1,000. a. What is the bond's promised yield to maturity? b. What is its expected yield (.e., the possible yields weighted by their probabilities)? Note: Enter your answers as a percent rounded to 2 decimal places. a. Promised yield b. Expected yield % %

18 YIELD TO MATURITY AND YIELD TO CALL Kempton Enterprises has bonds outstanding with a $1,000 face value and 10 years left until maturity. They have an 11% annual coupon payment, and their current price is $1,185. The bonds may be called in 5 years at 109% of face value (Call price = $1,090). What is the yield to maturity? What is the yield to call if they are called in 5 years? Which yield might investors expect to earn on these bonds? Why? The bond’s indenture indicates that the call provision gives the firm the right to call the bonds at the end of each year beginning in Year 5. In Year 5, the bonds may be called at 109% of face value, but in each of the next 4 years, the call percentage will decline by 1%. Thus, in Year 6, they may be called at 108% of face value; in Year 7, they may be called at 107% of face value; and so forth. If the yield curve is horizontal and interest rates remain at their current level, when is the latest that investors might expect the firm to call the…

Problem 6-23 Real Returns (LO3) Suppose that you buy a TIPS (inflation-indexed) bond with a 2-year maturity and a (real) coupon of 4.4% paid annually. If you buy the bond at its face value of $1,000, and the inflation rate is 8.60% in each year. a. What will be your cash flow in year 1? Note: Do not round intermediate calculations. Round your answer to 2 decimal places. Cash flow b. What will be your cash flow in year 2? Note: Do not round intermediate calculations. Round your answer to 2 decimal places. Cash flow c. What will be your real rate of return over the two-year period? Note: Enter your answer as a percent rounded to 1 decimal place.

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