Question

Which of the following statements is false?

None of the options

Bonds that are subordinated are associated with higher risk.

An increase in interest rates causes bond prices to decrease.

With the passage of time within a coupon payment period, a bond's accrued interest decreases.

When bonds sell for a premium, their required returns are lower than coupon rates.

Answer 1

None of the options is false.

Bonds that are subordinated are associated with higher risk because they are repayable after other debts have been paid, they are more risky for the lender of the money. Subordinated debts typically have a lower credit rating and therefore, a higher yield and also higher risk than senior debt. So, this statement is true.

An increase in interest rates causes bond prices to decrease because a bonds future cash payments will not change but the market interest rates will change frequently. The change in the market interest rates will cause the bond's present value or price to change. For example, if the market rate increases to 7%, and an existing bond is promising to pay only 6%, the 6% bond will not be worth its face value or maturity value. For it to be sold, the price will have to be less than the maturity amount. However, if the market rates drop to 5%, an existing bond that is promising to pay 6% will be very attractive. As a result, this bond will sell for more than its maturity value. So, this statement is also true.

With the passage of time within a coupon payment period, a bond's accrued interest decreases because the payments are made and the accrued interest for the time being decrease and again when the new coupon payment period starts accrued interest starts to increase. So, this statement is true.

When bonds sell for a premium, their required returns are lower than coupon rates because a bond that offers bondholders a lower interest or coupon rate than the current market interest rate would likely be sold at a lower price than its face value. This lower price is due to the opportunity investors have to buy a similar bond or other securities that give a better return and therefore if a bond sells for a premium their required returns are lower than the coupon rates. So, this statement is also true.

As all options are true, none of them is false and that is the correct option to choose.