Question

Three $1,000 face value, 10-year, noncallable, bonds have the same amount of risk, hence their YTMs are equal. Bond 8 has an 8% annual coupon, Bond 10 has a 10% annual coupon, and Bond 12 has a 12% annual coupon. Bond 10 sells at par. Assuming that interest rates remain constant for the next 10 years, which of the following statements is CORRECT? a. 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 b. Bond 8 sells at a discount (its price is less than par), and its price is expected to increase over the next year. c. Over the next year, Bond 8's price is expected to decrease, Bond 10's price is expected to stay the same, and Bond 12's price is expected to increase. d. Bond 12 sells at a premium (its price is greater than par), and its price is expected to increase over the next year. e. Bond 8's current yield will increase each year.

Answer 1

Answer: Option D : Bond 12 sells at a premium (its price is greater than par), and its price is expected to increase over the next year.

Explanation:

Bond 12 sells at a premium (its price is greater than par), and its price is expected to increase over the next year because we can see that for larger cash flows from its higher coupons, Bond 12 would be neutral to interest rate changes, which implies that it will grow with less interest rate risk.