Why does the expected return of a corporate bond not equal its yield to maturity

Question

Why does the expected return of a corporate bond not equal its yield to maturity?

(Select the choice below.)

A. The expected return is the actual return, but the IRR of the investment opportunity is not the yield

B. The expected return of a bond with risk is less than the bonds yield to maturity because the yield is calculated using the promised cash flows, which are not necessarily the actual or expected cash flows.

C. The expected return is what is expected while the yield is what you actually get.

D. The expected return is greater than the yield because the IRR of the investment in the bond exceeds the yield.

Explanation / Answer

The expected return of a corporate bond, which is the firm’s debt cost of capital, equals the risk-free rate of interest plus a risk premium. The expected return is less than the bond’s yield to maturity because the yield to maturity of a bond is calculated using the promised cash flows, not the expected cash flows.

Therefore Option B is correct.

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