Question

Consider an annual coupon bond with a $1000 par value and 5 years to maturity. The yield to maturity is 13% and the coupon rate is 10%. If the yield to maturity is held constant, which of the following can be inferred about this bond?

a		this bond is selling at a premium and the price will increase with time
b		this bond is selling at a premium and the price will decrease with time
c		this bond is selling at a discount and the price will increase with time
d		this bond is selling at a discount and the price will decrease with time
e		this bond is selling at par and the price will remain constant

Answer 1

When the YTM = Coupon rate, the bond trades at par. However, when the YTM > Counpon rate, the price of the bond is lower than the par value and it is a discount bond. When the YTM <Counpon rate, the price of the bond is higher than the par value and it is a premium bond.

This implies that the given bond is a discount bond so options a, b, and e are incorrect.

At the time of maturity, the maturity value is the par value. So as the price is lower than the par value the price needs to increase to reach the par value. This implies that option c is correct and d is incorrect.