Question

Why would a bond with a yield higher than the coupon rate sell at a discount? Why would a bond with a yield lower than the coupon rate sell at a premium?

Answer 1

Yield on a bond is comprised of two parts namely Coupon rate and Capital gain .

If any bond is selling at a discount ,it means there will be capital gain on redemption because bond at maturity will be redeemed generally at Face value and hence there will be a capital gain yield .

And yield on bond = Coupon rate + capital gain yield

And hence Bond will have yield greater than coupon rate

Similarly ,If bond is selling at a premium and will be redeemed at face value then there will be capital loss

And Yield = Coupon rate - Capital loss

And hence yield on bond selling at premium will be lesser than coupon rate