Investments, tenth edition

  

  Expected YTM  

  Stated YTM  

 Coupon payment 

 $45  

$45 

 Number of semiannual periods 

 20 periods 

 20 periods 

 Final payment 

 $700  

$1,000 

 Price  

$750  

$750 

 The yield to maturity based on promised payments is 13.7%. Based on the expected 

payment of $700 at maturity, however, the yield to maturity would be only 11.6%. The 

stated yield to maturity is greater than the yield investors actually expect to receive. 

 Example  14.11 

Expected vs. Promised Yield to Maturity 

 Example 14.11 suggests that when a bond becomes more subject to default risk, 

its price will fall, and therefore its promised yield to maturity will rise. Similarly, the 

default premium, the spread between the stated yield to maturity and that on otherwise-

comparable Treasury bonds, will rise. However, its expected yield to maturity, which 

ultimately is tied to the systematic risk of the bond, will be far less affected. Let’s 

continue Example 14.11. 

bod61671_ch14_445-486.indd   474

bod61671_ch14_445-486.indd   474

7/17/13   3:51 PM

7/17/13   3:51 PM

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  Bond Prices and Yields

475

 Suppose that the condition of the firm in Example 14.11 deteriorates further, and inves-

tors now believe that the bond will pay off only 55% of face value at maturity. Investors 

now demand an expected yield to maturity of 12% (i.e., 6% semiannually), which is 

.4% higher than in Example 14.11. But the price of the bond will fall from $750 to $688 

[ n   5  20;  i   5  6; FV  5  550; PMT  5  $45]. At this price, the stated yield to maturity based 

on promised cash flows is 15.2%. While the expected yield to maturity has increased by 

.4%, the drop in price has caused the promised yield to maturity to rise by 1.5%.