Question of the Week

If an investor has a required rate of return of 10% on a 20-year zero coupon bond with a par value of $1500, what should the investor pay for the bond when it is issued?

a) $437.12
b) $997.24
c) $578.23
d) $222.97
e) None of the Above


Answer:

The correct answer is d.

The value of a zero coupon bond is the present value of the lump-sum principal payment. There is no semi-annual coupon payments, only the principal repayment (of $1500) at maturity. Therefore the yield of the zero coupon bond equals the PV of the par value. In this question, the beginning value of the bond would be 1500 / (1.10^20) = $222.97.

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