Question

Three 10-year, $1,000 par value, noncallable bonds have the same level of risk. Bond EIGHT has an eight percent annual coupon, Bond TEN has a ten percent annual coupon, and Bond TWELVE has a twelve percent annual coupon. Bond TEN sells for $1,000. Assuming that interest rates remain constant for the next ten years, which of the following statements is CORRECT?

- Bond EIGHT sells at a discount (its price is less than par), and its price is expected to increase over the next year.

- Bond EIGHT’s current yield will increase each year.

- Bond TWELVE sells at a premium (its price is greater than par), and its price is expected to increase over the next year.

- Since the bonds have the same YTM, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity.

Answer 1

Bond price is determined by coupon rate and yield to maturity

If the interest rate is equal to the required yield, a bond will trade at par

If interest rate is less than yield, at discount and price will increase over the life to par value

If interest rate is more than yield, at premium and price will decrease over the life to par value

Since bond ten with 10% coupon trades at par, it means required yield = 10%

Hence, the correct statement is

- Bond EIGHT sells at a discount (its price is less than par), and its price is expected to increase over the next year.

Yield will remain constant

Bond TWELVE sells at a premium (its price is greater than par), and its price is expected to decrease

Bonds will have different price

Hence, all other statements are false