Which one of the following statements regarding bonds is true? A bond selling at premium is valued below its face value. A discount bond has a coupon rate that is below the bond’s yield to maturity. The current yield is always equal to the bond’s coupon rate. The coupon rate is adjusted with the market valuation of the bond
The Correct Answer and Explanation is:
Correct Answer:
A discount bond has a coupon rate that is below the bond’s yield to maturity.
Explanation:
A bond is a fixed-income investment representing a loan made by an investor to a borrower. Bonds typically include key features such as face value, coupon rate, market price, and yield to maturity (YTM).
A discount bond is one that sells below its face value. This typically happens when the coupon rate — which is the fixed interest paid annually as a percentage of the bond’s face value — is less than the yield to maturity. Investors demand a higher yield than the bond is paying, so the bond must sell at a discount to attract buyers. The yield to maturity reflects the total return an investor can expect if the bond is held until maturity, accounting for both interest payments and the difference between purchase price and face value.
Let us evaluate the other choices:
- “A bond selling at premium is valued below its face value” is incorrect. A bond selling at a premium is priced above its face value, not below. This occurs when the coupon rate is higher than the yield investors require.
- “The current yield is always equal to the bond’s coupon rate” is incorrect. The current yield is calculated as the annual coupon payment divided by the bond’s current market price. It equals the coupon rate only when the bond sells at par (equal to face value). If the bond is priced above or below par, the current yield will differ.
- “The coupon rate is adjusted with the market valuation of the bond” is also incorrect. The coupon rate is fixed when the bond is issued. It does not change based on market price movements.
In summary, a discount bond offers a lower coupon rate compared to its yield to maturity, making the correct statement the one about discount bonds and their relationship between coupon rate and YTM.
