5. We will use a numerical example to demonstrate this process. Assume a 20-year bond pays $118 per year (11.8 percent) in interest and $1,000 after 20 years in principal repayment. The current price of the bond is $1,085. We wish to determine the yield to maturity or discount rate that equates the future flows with the current price.

Since the bond is trading above par value at $1,085, we can assume the yield to maturity must be below the quoted interest rate of 11.8 percent (the yield to maturity would be the full 11.8 percent at a bond price of $1,000). As a first approximation, we will try 10 percent. Annual analysis is used.