An analyst wants to estimate the yield to maturity on a non-traded 4-year, annual pay bond rated A. Among actively traded bonds with the same rating, 3-year bonds are yielding 3.2% and 6-year bonds are yielding 5.0%. Using matrix pricing the analyst should estimate a YTM for the non-traded bond that is closest to:

3.8%

Explanation:

3 year bonds yielding 3.2%

6 year bonds yielding 5.0

Annual pay bond 4 years

Yielding bond+[ (Annual pay bond - Bonds years) / bond years] * (Yielding bond-Yeilding bonds)

Let plug in the formula

Interpolating: 3.2% + [ (4 - 3) / (6 - 3) ] * (5.0% - 3.2%)

=3.2%+[1/3 * (1.8%) ]

= 3.2% + (0.33333*1.8%)

=3.2%+0.006

=0.032+0.006

=0.038*100

=3.8%

Alternatively,

Interpolating: 3.2% + [ (4 - 3) / (6 - 3) ] * (5.0% - 3.2%) = 3.8%

In this case the analyst should estimate a YTM for the non-traded bond that is closest to: 3.8%