hi,
i am having trouble with the below question - as a zero coupon bond only pays at maturity, how does compounding frequency effect the calculation? the answer uses uses n = 6
A zero-coupon bond matures three years from today, has a par value of $1,000 and a yield to maturity of 8.5% (assuming semi-annual compounding). What is the current value of this issue?
Many thanks
While a zero coupon bond does not entitle annual payment of interest, it trades at a deep discount such that the amount the subscriber receives on maturity would compensate for the periodical interest the investor would receive if it was a plain bond. Hence, to compute the present value of the bond, the frequency of payments used would be 6 since frequency of interest compounding is semi annual.
Hope this helps!
This isn’t true.
It pays a coupon.
“How big a coupon?” you ask?
Zero percent, of course.
And, like most bonds, it pays half of its zero percent coupon every six months.
thank you - i get it (not sure if i 100% understand)… enough to get me over the line!
Whenever we talk about a bond’s YTM, it’s understood that the yield convention we’re using is BEY unless we explicitly say otherwise. That’s simply the convention that the bondsters use. It’s like driving on the right side of the road: it’s not intrinsically better than driving on the left (well, it turns out that it is, but that’s another discussion), but it’s a lot better than some doing it one way and some the other. Everyone has to follow the same convention or else chaos ensues.