Question

An investor is considering the purchase of a 2 year bond with a 5.5% coupon rate, with interest paid annually. Assuming the following sequence of spot rate: 1 year , 4% and 2 year, 3% the yield to maturity of the bond is:
A. 3.5%
B. 3.03 %
C. 3.98%

Answer 1

Summary :-

Yield to maturity is the total rate of return, that will have been earned by a bond when it makes all interest payments abd repays the original principal.

Whereas the spot rate is the rate of return earned by a bond when it is bought and sold on the secondary market without collecting interest payment.

Here in this question, its been asked to find out the yield to maturity from the sport rates for 2 years of the bond respectively.

For this ,we need to consider Face value and redemption value of the bond as, say for $ 1000 to solve the question. Then present value of the bond need to be calculated by discounting it with spot rates given for the respective period. Once present value have been arrived, this present value is to be used to find out the yield to maturity by using quadratic equation.