Expected yield You own a 5% bond 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. What is the bond’s promised yield to maturity? What is its expected yield (i.e., the possible yields weighted by their probabilities)?
To determine: The bonds promised yield to maturity and expected yield.
Yield to maturity (YTM) is the overall return anticipated on a bond throughout its maturity period and it is considered as a long-term bond yield and represented as an annual rate.
Explanation of Solution
Computation of bonds promised yield to maturity and expected yield is as follows:
Therefore, to ascertain the expected yield, the expected pay off at maturity is needed and given a 10% probability that only 40% of the promised payment will be received.
Therefore, the expected yield is as follows:
Therefore, the bonds promised yield to maturity and expected yield is 12.77% and 9.42% respectively.
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Chapter 23 Solutions
PRIN.OF CORPORATE FINANCE
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