In the Hull's book, chapter 4.4, it says :
The par yield for a certain bond maturity is the coupon rate that causes the bond price to equal it's par value.
Then for this question (4.18) :
“When the zero curve is upward sloping, the zero rate for a particular maturity is greater than the par yield for that maturity. When the zero curve is downward sloping the reverse is true.” Explain why this is so.
the answer is :
The par yield is the yield on a coupon-bearing bond. The zero rate is the yield on a zero-coupon bond. When the yield curve is upward sloping, the yield on an N-year coupon-bearingbond is less than the yield on an N-year zero-coupon bond. This is because the coupons are discounted at a lower rate than the N-year rate and drag the yield down below this rate. Similarly, when the yield curve is downward sloping, the yield on an N-year coupon bearing bond is higher than the yield on an N-year zero-coupon bond.
- First, it's not very clear in my mind, is the par yield a coupon rate or a yield ?
- Secondly, i don't understand the answer, what does he mean by "drag the yield down below this rate" ? When he says "are discounted at a lower rate", of which rate does he talk about ? The bond's yield ?