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Chapter 15: Q4. (page 606)

A bond has two years to mature. It makes a coupon payment of \(100 after one year and both a coupon payment of \)100 and a principal repayment of \(1000 after two years. The bond is selling for \)966. What is its effective yield?

Short Answer

Expert verified

The effective yield is 12%.

Step by step solution

01

Explanation

The effective yield is the rate of interest at which the present value is discounted.

At the end of one year, the coupon payment will be $100, and at the end of two years, the payment will be $1100 (=$100 + $1000). The present value of the bond is $966.

According to the problem,

966=1001+r-1+11001+r-2966=1001+r1+11001+r29661+r2=1001+r+1100966+1932r+966r2=100+100r+1100966r2+1832r-234=0r=-1832卤18322-4脳966脳-2342脳966=-1832卤3356224+9041761932=-1832卤2064.071932=-1832+2064.071932=232.071932=0.1201=12%

The negative value of r is ignored; thus, the effective interest rate will be 12%.

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Most popular questions from this chapter

The market interest rate is 5 percent and is expected to stay at that level. Consumers can borrow and lend all they want at this rate. Explain your choice in each of the following situations:

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Suppose you can buy a new Toyota Corolla for \(20,000 and sell it for \)12,000 after six years. Alternatively, you can lease the car for \(300 per month for three years and return it at the end of the three years. For simplification, assume that lease payments are made yearly instead of monthly鈥攊.e., that they are \)3600 per year for each of three years.

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