Question

A fixed Coupon Bond currently has a price of $1,100 and a yield of 6%.  All else being equal, you know if the SAME bond were to have a yield of 8%, its price would be $900.  The coupon rate of this bond _____________.

a. must be greater than 8%

b. must be less than 6%

c. must be between 6% and 8%

d. not enough information to say

e. must be 7%

Answer 1

Option (c) : must be between 6% and 8%

Explanation:

The relation between a bond yield and its coupon is as below:

~ yield > coupon rate : the bond trades at a discount

~ yield < coupon rate : the bond trades at a premium

~ yield = coupon rate : the bond trades at Par

The reason is that the yield of a bond is the expectations of the bond holder from the company whereas the coupon rate is what the company actually pays.

Now, if the company pays more than the expectation of bondholders, then the bond trades at par and vice-versa.

In the given question, at 6% yield bond is at premium , which means that coupon rate is higher than 6%.

However, at 8% yield bond is at discount, which means that coupon rate is lower than 6%.