Question

A two-year bond with a par value of $1,000 making annual coupon payments of $90 is priced at $1,000. What is the yield to maturity of this bond?

1) 5%
2) 7%
3) 9%
4) Cannot be determined

Answer 1

The yield to maturity of a two-year bond with a par value of $1,000, an annual coupon of $90, and priced at par, is 9%. This matches option 3 of the choices provided. The yield to maturity equates to the bond's coupon rate when the bond is priced at its par value.

Step-by-step explanation:

The question asks to calculate the yield to maturity (YTM) of a two-year bond with a par value of $1,000, an annual coupon payment of $90, and priced at its par value. The YTM is the total return expected on a bond if the bond is held until maturity.

In this case, since the bond is priced at par value, the YTM is equal to the coupon rate, which is calculated as the annual coupon payment divided by the bond's par value. The annual coupon payment is $90, therefore, the coupon rate (and hence the YTM) is $90 / $1,000 = 9%. Hence, the YTM of this bond is 9%, which corresponds to option 3 among the provided choices.

This calculation doesn't factor in any capital gains or losses since the bond is held until maturity and is redeemed at par value, eliminating the effect of market interest rate fluctuations on the price of this bond if it were sold before maturity.