The yield rate on a one year zero-coupon bond is currently 7% and the yield rate on a 2-year zero coupon bond is currently 8%. The Treasury plans to issue a two year bond with a 9% annual coupon, maturing at $100 par value. Determine the yield to maturity of the two year coupon bond.

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Alden

2 February, 00:36

The yield rate on a one year zero-coupon bond is currently 7% and the yield rate on a 2-year zero coupon bond is currently 8%. The Treasury plans to issue a two year bond with a 9% annual coupon, maturing at $100 par value. Determine the yield to maturity of the two year coupon bond.

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Ainsley Martin · Answer 1

The Yield to maturity is 7.96%.

Explanation:

The two-year Treasury Bond will generate the cashflow as below:

Year 1: Coupon payment = 9% x 100 = $9

Year 2: Coupon payment + face value repayment = (9% x 100 + $100) = $109

Present value of the two cash flows above is : 9/1.07 + 109/1.08^2 = $101.86

The yield to maturity need to be found is the discounted rate of the two mention-above cash flows which equals the present value of the two cash flows to the present value of $101.86 as calculated above.

=> 9 / (1+YTM) + 109 / (1+YTM) ^2 = 101.86 = > YTM = 7.96%.