Question

(a) Suppose you hold a bond, and the current one-year holding period rate of return is 6%. And we further know that the yield to maturity for this bond is also 6% now. Could you tell me which rate will be higher if the interest rate decreases? Why?

(b) Suppose there are two bonds with the same yield-to-maturity and date to mature; but one is sold at premium, the other one is sold at discount. Could you tell me which bond has a higher coupon? Why?

(c) Is there any difference in prices between these two bonds mentioned in (b) at the end of their duration? Why?

Answer 1

a. if the interest rates decreases, price of the bond increases because the bond is paying a coupon of 6% but as the interest rates in market fell, the investors in the market are expecting lower interest rate than 6% thus the bond price will be higher

b. The Bond that has been selling at premium will have higher coupon because the investor in market is expecting lower interest coupon but the bond which is selling at premium is offering higher coupon rate.

c. there wont be any difference in price at the end of duration and they will be redeemed at face value. this is an assumption on which the bond prices or YTM are calculated.