Chapter 6, Problem 10PROB

Summary Introduction

A five-year zero-coupon bond with face value of $1,000 is currently selling for $621.

Zero coupon bonds or plain vanilla bonds are one which do not give regular interest income. These bonds are also known as discount bonds as the price of the bond is below their par value. These are simple bonds and give the par value of the bond at the end of the maturity period.

Yield to maturity (YTM) is the required rate of return when the bonds are held till maturity. Since, zero-coupon bonds do not give periodic interest rates, YTM can be calculated from the bond price formula of a zero-coupon bond:

$V_d=M\left(\frac{1}{{\left(1+r_d\right)}^N}\right)$

Where,

Where,

N = number of periods

M = Maturity or Face value

rd = rate of return

Vd = Value of the bond