Reading 62: Risks Associated with Investing in Bonds-LOS b 习 par, 2011, discount, relative, required

1215

Session 15: Fixed Income: Basic Concepts
Reading 62: Risks Associated with Investing in Bonds

LOS b: Identify the relations among a bond's coupon rate, the yield required by the market, and the bond's price relative to par value (i.e., discount, premium, or equal to par).

 

 

Given that the coupon rate of a bond is higher than the market interest rate on bonds with similar maturities and payment structures, the bond will be trading:

A) at a discount.

B) at a premium.

C) at par value.

---

 

If the bond provides investors with a higher coupon rate than the market interest rate the bond has to be trading at a premium relative to its par value otherwise there is an arbitrage opportunity.

1215

Jonathon Silver, CFA, has a client, Alyce Grossberg, whose only current investment requirement is that she wants to buy a premium bond. The required market yield is currently 7.25% at all maturities. Which of the following $1,000 face value bonds should Silver select for Grossberg’s portfolio?

A) 15-year, zero-coupon bond priced to yield 9.00%.

B) 10-year, 7.00% semi-annual coupon bond.

C) 10-year, 8.00% semi-annual coupon bond.

---

A bond sells at a premium when the coupon rate is greater than the required market yield. Here, the 10-year, 8.00% semi-annual coupon bond would sell above par, or at a premium.

The 15-year, zero-coupon bond priced to yield 9.00% would sell at a discount. Zero-coupon bonds sell at a discount from par, because they pay no coupon. (Coupon rate = 0.00%.) The 10-year, 7.00% semi-annual coupon bond would also sell at a discount, because the coupon rate is less than the required market yield. Note: The information that this is an annual coupon bond is not relevant for this question.

For the examination, remember the following relationships:

Type of Bond	Market Yield to Coupon	Price to Par
Premium	Market Yield < Coupon	Price> Par
Par	Market Yield = Coupon	Price = Par
Discount	Market Yield> Coupon	Price < Par

1215

If the market rate of interest is greater than the coupon rate, the bond will be valued:

A) at par.

B) less than par.

C) greater than par.

---

If the Coupon Rate > market yield, then bond will sell at a premium.
If the Coupon Rate < market yield, then bond will sell at a discount.
If the Coupon Rate = market yield, then bond will sell at par.

1215

Gabrielle Daniels and Edin Roth, CFA candidates, are discussing the relationship between a bond’s coupon rate and the required market yield. Looking through the local newspaper, they see a new-issue, 10-year, $1,000 face value 8% semi-annual coupon bond priced at $950. Daniels makes the following statements. Which statement does Roth tell her is correct?

A) The bond is selling at a premium.

B) The bond is selling at a discount.

C) The current market required rate is less than the coupon rate.

---

When the issue price is less than par, the bond is selling at a discount.

We also know that the current market required rate is greater than the coupon rate because the bond is selling at a discount.

1215

Kirsten Thompson, CFA candidate, is studying the relationships between a bond’s coupon rate and the required market yield. One study question concerns a new-issue, 15-year, $1,000 face value 6.75% semi-annual coupon bond priced at $1,075. Which of the following choices describes the bond and the relationship of the bond’s market yield to the coupon?

A) Premium bond, required market yield is less than 6.75%.

B) Discount bond, required market yield is greater than 6.75%.

C) Premium bond, required market yield is greater than 6.75%.

---

When the issue price is greater than par, the bond is selling at a premium. We also know that the current market required rate is less than the coupon rate of 6.75%, because the bond is selling at a premium.

For the examination, remember the following relationships:

Type of Bond	Market Yield to Coupon	Price to Par
Premium	Market Yield < Coupon	Price> Par
Par	Market Yield = Coupon	Price = Par
Discount	Market Yield> Coupon	Price < Par