Final answer:
The key assumption that differentiates the promised yield from the expected return is related to risk, specifically default and interest rate risk. The promised yield is a guaranteed rate if there are no defaults or changes in the interest rate environment, whereas the expected return considers the potential variability due to these risks.
Step-by-step explanation:
What key assumption makes the promised yield different from the expected return? The key assumption that makes the promised yield different from the expected return is primarily related to risk, specifically default risk and interest rate risk. The promised yield of a bond is the rate of return it guarantees at the time of purchase, assuming that there will be no defaults and the interest rate environment remains stable. In contrast, the expected return takes into account the actual probability of receiving the payments as promised, which includes the potential for default and changing interest rates impacting the bond's market value.
Bonds that come with a higher promised yield, such as high-yield or junk bonds, imply a relatively high chance of default. An investor's expected return accounts for the risk that the issuer may fail to make the promised payments. Interest rate risk also plays a significant role. If the market interest rates rise, the value of existing bonds with lower interest rates will typically decrease, affecting their return if sold before maturity.
The expected rate of return for any financial investment is calculated by considering various factors, including the investment's risk level. A high-risk investment should, on average, offer a higher expected return to compensate for the risk. This is in contrast to the promised yield, which does not fluctuate in the same way, as it is fixed at the time the investment is made.