In January, 2002, Jones Company issues a pure-discount bond with a pro

In January, 2002, Jones Company issues a pure-discount bond with a promised payment of X=$1000 that matures in T=5 years. The market price of the bond is P=$777 . The bond is default- risky. Specifically, the probability is 0.

8 that Jones Company will pay the full amount of X at maturity, and is 0.2 that the firm will default, in which case the payoff to bondholders will be only $555 . Calculate the bond’s promised yield to maturity, y, and expected return to maturity, rD.
y rD
a. 8.18% 5.18%
b. 5.18% 5.18%
c. 8.18% 3.23%
d. 5.18% 3.23%
e. 5.18% 1.57%
FORMULAS: y = [X/P]1/T –1; rD = [E(PAY)/P]1/T –1, where E(PAY)= p[X] + (1-p)[X’]

ANSWER

D