Which of the following is correct for a bond currently selling at a premium to par?Select one:a.Its current yield is higher than its coupon rate.b.Its current yield is lower than its coupon rate.c.Its yield to maturity is higher than its coupon rate.d.Its default risk is extremely low.
Question
Which of the following is correct for a bond currently selling at a premium to par?Select one:a.Its current yield is higher than its coupon rate.b.Its current yield is lower than its coupon rate.c.Its yield to maturity is higher than its coupon rate.d.Its default risk is extremely low.
Solution
The correct answer is:
b. Its current yield is lower than its coupon rate.
Here's why:
a. Its current yield is higher than its coupon rate: This is incorrect. For a bond selling at a premium, the current yield (annual interest payments divided by market price) would be lower than the coupon rate (annual interest payments divided by par value) because the market price is higher than the par value.
b. Its current yield is lower than its coupon rate: This is correct. As explained above, the current yield would be lower than the coupon rate for a bond selling at a premium.
c. Its yield to maturity is higher than its coupon rate: This is incorrect. For a bond selling at a premium, the yield to maturity (the total return if the bond is held to maturity) would be lower than the coupon rate. This is because the bondholder would receive less at maturity (the par value) than what they paid for the bond (the premium price).
d. Its default risk is extremely low: This is not necessarily true. While a bond selling at a premium might indicate that investors perceive the bond to be lower risk, it does not guarantee that the default risk is extremely low. Other factors, such as the issuer's creditworthiness and market conditions, also affect the bond's default risk.
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