Question

The yield to maturity on a coupon bond is _____.(A) always greater than the coupon rate.(B) the rate an investor earns if she holds the bond to the maturity date, assuming she can reinvest all coupons at the current yield.(C) the rate an investor earns if she holds the bond to the maturity date, assuming she can reinvest all coupons at the yield to maturity.(D) only equal to the internal rate of return of a bond when the bond is priced at par.(E) greater than both the current yield and coupon rate when the bond is priced at a premium to par.

Answer 1

Answer:

The answer is (C) the rate an investor earns if she holds the bond to the maturity date, assuming she can reinvest all coupons at the yield to maturity.

Explanation:

Yield to maturity is the internal rate of return for investor if he/she holds the bond to maturity. In other words, it is the discount rate that brings net present value of the coupons and principal repayment received from the current time to bond maturity equal to its current bond's price ( thus, assuming all the coupon can be reinvested at the yield to maturity). So, (C) is the correct choice.

(A) is not correct because Yield to maturity can be either higher, lower or equal to coupon rate.

(B) is not correct because the assumption is all the coupons can be reinvested at yield to maturity, not current yield.

(D) is not correct because yield to maturity is the internal rate of return of the bond given the bond is hold until maturity.

(E) is not correct because bond is priced at premium to par when yield to maturity is lower than its coupon rate.