Question

Two years ago an investor purchased a 4% semi-annual compounding coupon bond with a remaining maturity of 20 years at a price of (at that time) 90% of par. Today, i.e. two years after the purchase, the investor realizes that the bond has exactly the same price like it had two years ago (i.e. 90%). Based on this information, which of the following answers is correct:

a) The YTM of the 4% Bond today is the higher than two years ago.

b) Overall, the profit for the investor from this investment over the two years is Zero.

c) Over the remaining life of the bond, the value of the principal exceeds the value of the coupons.

d) If the investor held the 4% coupon bond until maturity, the overall return from this investment over the 18 years would be 100% minus 90%, i.e. 10%.

e) None of the above answers is correct.

Answer 1

Option A is correct. The YTM of the 4% Bond today is the higher than two years ago.

Because the bond is trading at discount two years ago which means that the present value of coupon and maturity value is $900 ($1000*90%) two years ago and now it is of the same price which happens when the YTM increases and thus to generate same present value of cash flows of coupon and maturity value