Bond A is a discount bond with face value of $100 and maturity of 10 years. Bond

ID: 1149015 • Letter: B

Question

Bond A is a discount bond with face value of $100 and maturity of 10 years.

Bond B is a discount bond with face value of $100 and maturity of 2 years.

Suppose the yield to maturity on both securities is 4%.

Over the course of the year, prevailing yields are expected to change according to the table below:

Calculate the expected return of bond B

Hints: Discount bonds pay no coupon. Next year, the maturity on bond B will be 1 year.

Answer as a percentage, DO NOT enter a % sign. Round to two decimal places.

Next year's yield Probability 3% 0.33 4% 0.34 5% 0.33

Solution:

Price of the bond 100/1.04^2 = 92.45

Prices under the different cases:

At 3%: 100/1.03=97.09

At 4%: 100/1.04=96.15

At 5%: 100/1.05=95.23

Expected return = (97.09 * 0.33) + (0.34 * 96.15) + (95.23 * 0.33) = 96.16