Investor returns on a Bond par, corporate, discount, receive, interest

ashycal

An investor buys a 6% coupon 5-year corporate bond priced to yield 7%. If rates remain unchanged when the investor sells the bond in 2 years, the investor will receive a:

A) capital loss.

B) total return equal to the coupon yield.

C) capital gain.

Answer is C
Current yield of a bond = coupon payment / market price of bond. Bonds with a coupon lower than the prevailing interest rate will trade at a discount to par. If interest rates remain the same as the bond nears maturity the price will increase towards its par value. Thus, when they are sold, the investor will receive a capital gain.

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Since the rates remain unchanged during the 2 yrs the price of the bond does not change and hence the returns the investor earns is coupon yield. ..

bluejazzy

There is a capital gain since ytm > coupon the bond is a discount bond, you purchase the bond for less than par value but you receive par when the bond matures.

Capital gain/loss only applies to the principle

homie

Same as you said it has to be accounted for maturity affect.

So I put all the numbers in calculators and kept chcking the prices while reducing maturity.. and we see the price appreciate - so a capital gain

johnnyBuz

ok agreed...but the coupon payments are also a source of returns for the investors

Micholien

It really shows how a simple question can get tricky...

FVPV

The wording is "when he sells he will receive a ..."

Coupons are only relevant for figuring out if it is a premium or discount bond in this question.

ogoluwa

ohhkkk.....need to be very careful while reading huh