Question

A bond with a face value of $1,000 pays $50 in interest annually and matures in 1 year. The bond was purchased for $980. What is the yield at maturity and coupon rate? A. The yield to maturity is 5.00% and the coupon rate is 5.10% B. Can't tell from the information given C. The yield to maturity is 7.14% and the coupon rate is 5.00% D. The yield to maturity is 5.10% and the coupon rate is 7.00% E. The yield to maturity is 5.00% and the coupon rate is 5.00%

Answer 1

Since in the given case, the bond is trading at less than its par value, it denotes that this is a discount bond. In a discount bond the yield to maturity is always greater than the coupon rate.

The coupon rate will be as follows:

= Interest amount / Par value

= $ 50 / $ 1,000

= 5%

So, the option in which the yield to maturity is greater than the coupon is option C.

Hence the correct answer is option C.

We can also use the below excel function in order to calculate the yield to maturity as follows:

= RATE(N,PMT,PV,FV)

= RATE(1,50,-980,1000)

It shall give I/Y equal to 7.14%