Final answer:
The yield to maturity (YTM) of a bond is the rate of return that is earned if the bond is held until its maturity date, considering the bond's current market price, par value, and time to maturity. Calculating YTM involves using the formula that equates the bond's current market price to the present value of its future cash flows to solve for the rate. Given the bond's current price and par value, YTM is found through iterative calculation or a financial calculator.
Step-by-step explanation:
The yield to maturity (YTM) of a zero-coupon bond is the rate of return that is promised to the investor if the bond is held to its maturity date. YTM is calculated based on the present value of the bond, its par value, and the time to maturity. Given a 10-year zero-coupon bond with a par value of $1,000 and a current market price of $625, we need to find the rate that equates the present value (market price) of the bond's future cash flows (its face value at maturity) to its current market price.
To calculate the yield to maturity for this bond, we can use the formula:
Current Market Price = Par Value / (1 + YTM)^n
Where Par Value is the face value of the bond, YTM is the yield to maturity, and n is the number of years to maturity. After inputting the values ($625 = $1,000 / (1 + YTM)^10), we solve for YTM through iterative calculation or financial calculators to find the correct yield to maturity that matches the options provided in the question.