Shankalot Investment Company plans to purchase either (1) zero-coupon bonds that have ten years to maturity, a par value of $100 million, and a purchase price of $40 million, or (2) bonds with five years to maturity, a 9 percent coupon rate (paid annually), a par value of $40 million, and a purchase price of $40 million.
A) What is the yield to maturity on each bond?
B) What is the duration of each bond?
C) If the bonds have the same level of default risk, explain how it is possible for the bonds to have different yield to maturities.
D) Assume that Shankalot believes the yield to maturity on the zero-coupon bond will be 11 percent five years from today. What annual return does Shankalot expect to earn on each bond over a five-year holding period?