4
$\begingroup$

Which of the following statements is correct?

a. If a bond’s yield to maturity exceeds its coupon rate, the bond’s current yield must also exceed its coupon rate.

b. If a bond’s yield to maturity exceeds its coupon rate, the bond’s price must be less than its maturity value.

The correct answer is b. I would like to know why option a is incorrect.

If bond price is less than maturity value, then current yield = (annual coupon payment)/(current bond price) > coupon rate. Is there anything wrong with this reasoning?

$\endgroup$
2
  • 1
    $\begingroup$ Where does that come from? CFA exercises? $\endgroup$
    – SRKX
    Commented Mar 28, 2013 at 13:06
  • $\begingroup$ It comes from the book 'Essentials of Financial Management' $\endgroup$
    – Ong Junjie
    Commented Mar 29, 2013 at 2:17

3 Answers 3

1
$\begingroup$

(a) is false

Consider a zero coupon bond. Yield to maturity clearly exceeds the coupon rate, but

$$ Y_\text{current} = 0 = \text{Coupon} $$

while the question asks about a strict inequality.

$\endgroup$
2
  • $\begingroup$ Wow ! Nice one. $\endgroup$ Commented Mar 29, 2013 at 12:20
  • $\begingroup$ The answer would be more complete if you restated the definitions of the 3. $\endgroup$
    – SRKX
    Commented Mar 29, 2013 at 17:16
0
$\begingroup$

No you're right. If YTM > coupon rate, then the bond is selling below par and therefore current yield > coupon rate.

$\endgroup$
0
$\begingroup$

If you're talking about a straight, option-free bond, then A is absolutely correct. It's rather easy to prove doing the math. However, if it's not a straight bond then you may have cases where A wouldn't be true(puttable bonds in some cases), but then B would be false in those cases as well. I think you need to burn whatever book you're reading.

$\endgroup$

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service and acknowledge you have read our privacy policy.

Not the answer you're looking for? Browse other questions tagged or ask your own question.