FRM Part I · FRM Exam Part I · Corporate Bonds
A two-year zero-coupon bond has face value 1,000. The risk-free rate is 4% and the credit spread is 2%, both annually compounded, so the discount rate is 6%. What is the bond's price, closest to?
The price is about 890.0. The bond is discounted at the risky yield of 6% (4% risk-free plus 2% spread) for two years: 1,000 divided by 1.06 squared, which is 1.1236, giving 890.0. Using only the risk-free rate would overstate the price.
- A890.0Correct
- B924.5
- C1,000.0
- D855.6
Explanation
Price = 1,000/1.06^2 = 1,000/1.1236 = 890.00. Using 1,000/1.04^2 gives 924.56, which ignores the spread. 855.6 comes from discounting at 8.
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