Question

If an investor pays more for a bond than the bond’s face (maturity) value, the yield that the investor will earn, if they hold that bond until maturity, will be a higher value than the bond’s coupon.

a) True

b) False

* Explain why?

Answer 1

a] False.

Explanation:

Once a bond is issued, the expected cash flows to the holder does not change. That is the regular coupon payments and the maturity value remain the same, whatever the market rate of interest. Hence, when more than the face value is paid to acquire a bond, it will mean that the yield will be lower than the coupon rate.

For example:

Consider a bond that is issued at a face value of $1000, with annual coupon of 10% [this amounts to annual interest payments of $100] and having maturity of 10 years.

Further, let it be that the bond is quoted immediately theerefter at a price of $1,100. Still the expected coupons or the face value do not change though the price is up. This will naturaly mean lower yield.

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