Question

A 10-year bond pays an annual coupon, its YTM is 8%, and it currently trades at a premium. Which of the following statements is CORRECT? a. The bond's current yield is less than 8%. b. If the yield to maturity remains at 8%, then the bond's price will decline over the next year. c. The bond's coupon rate is less than 8%. d. If the yield to maturity increases, then the bond's price will increase. e. If the yield to maturity remains at 8%, then the bond's price will remain constant over the next year.

Answer 1

Answer:

If the yield to maturity remains at 8%, then the bond's price will decline over the next year.

Explanation:

When the bonds sells at a premium it means that the coupon payment is greater than the yield to maturity, which means that the income generated by the bond is greater than return required by the investor and because of this the bond sells at a premium because the investor is willing to pay more for the bond as it offers more income than its required rate of return. With a premium the bond price increases to a point where the coupon and required return become equal. When the bond has 10 years to maturity it means that it will give 10 equal payments to the investor which will be greater than the investors required return therefore the investor will be willing to pay a higher price for the bond, as the maturity decreases the number of payments which will be higher than the required return also decrease, so for example if there are 5 years to maturity then the bond will pay 5 payments that are greater than the required return so the investor will be paying a lower premium compared to when he was getting 10 payments that payed more than his required return.