An investor is comparing two bonds of similar structure from the same issuer. Which bond should the investor buy?
The bond with the highest yield if the two bonds have the same maturity date
The bond with the highest coupon and the lowest yield
The bond maturing last as that has the lowest risk
The bond with the highest price as that offers the highest return
The Correct Answer and Explanation is:
Correct Answer: The bond with the highest yield if the two bonds have the same maturity date.
Explanation:
When an investor is comparing two bonds from the same issuer with similar structures and identical maturity dates, the yield becomes the most critical factor in deciding which bond to purchase. Yield represents the effective return an investor will earn by holding the bond until maturity, taking into account the purchase price, coupon payments, and time to maturity.
Why Yield Matters:
The yield to maturity (YTM) is a comprehensive measure of a bond’s return, encompassing both the coupon payments and any capital gains or losses incurred if the bond is bought at a price different from its face value. If two bonds have the same maturity, the one with the higher yield will generate a greater return for the investor, assuming no default by the issuer.
Misleading Alternatives:
- “The bond with the highest coupon and the lowest yield” may seem attractive due to higher periodic income. However, a lower yield indicates the bond is overpriced relative to its return, reducing overall profitability.
- “The bond maturing last as that has the lowest risk” is incorrect. Longer-maturity bonds typically have higher interest rate risk and price volatility, not lower risk.
- “The bond with the highest price as that offers the highest return” is misleading. A higher price usually results in a lower yield, meaning a lower return unless offset by high coupon payments—which is already factored into the yield.
Conclusion:
When comparing similar bonds from the same issuer with the same maturity, the investor should choose the bond offering the highest yield, as it reflects the most favorable risk-adjusted return. This strategy maximizes income while holding credit risk and time horizon constant.
