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Difficulty: HardDebt Securities and Bond Structure

An investor purchases a 1,0001,000 par value corporate bond carrying a 6%6\% stated annual coupon that matures in 1010 years. The bond is currently trading in the secondary market at a discounted price of 920920 and is callable in 55 years at par value (1,0001,000). Which of the following lists the four yield measures for this bond in order from highest to lowest?

  1. Yield to Call, Yield to Maturity, Current Yield, Nominal YieldAnswer
  2. B
    Nominal Yield, Current Yield, Yield to Maturity, Yield to Call
  3. C
    Yield to Maturity, Yield to Call, Current Yield, Nominal Yield
  4. D
    Current Yield, Nominal Yield, Yield to Maturity, Yield to Call

Answer

Yield to Call, Yield to Maturity, Current Yield, Nominal Yield
When a bond trades at a discount (920marketprice<920 market price < 1,000 par), the investor receives annual interest payments plus capital appreciation upon redemption at par. Nominal yield is fixed at the coupon rate (6.0%6.0\%). Current yield reflects annual interest divided by market price ($60/$920=6.52%\$60 / \$920 = 6.52\%). Yield to Maturity adds the annual discount accretion over 10 years to the current yield. Yield to Call accelerates that same discount accretion into 5 years, resulting in the highest annualized rate of return. Therefore, the descending order is Yield to Call > Yield to Maturity > Current Yield > Nominal Yield.

Step-by-Step Solution

1
Determine the bond's pricing relationship relative to par value.
The bond's market price (920)isbelowitsparvalue(920) is below its par value ( 1,000), placing it at a discount.
Identifying discount status establishes the foundational yield hierarchy rules.
2
Calculate Nominal Yield and Current Yield.
Nominal Yield is fixed at 6.0%6.0\%. Current Yield is $60$920≈6.52%\frac{\$60}{\$920} \approx 6.52\%, showing Current Yield > Nominal Yield.
Current yield factors in the lower purchase price relative to annual coupon income.
3
Evaluate Yield to Maturity (YTM) and Yield to Call (YTC).
YTM incorporates the $80\$80 capital gain over 1010 years (+0.8%+0.8\% per year approx.), while YTC accelerates that same $80\$80 capital gain over only 55 years (+1.6%+1.6\% per year approx.).
Faster realization of the discount accretion increases the annualized return.
4
Arrange the yields in descending order (highest to lowest).
Yield to Call > Yield to Maturity > Current Yield > Nominal Yield.
This sequence correctly reflects the relationship across all four yield measures for a discount bond.

Key Concept

Yield Hierarchy for Discount Bonds
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Topics

Debt Securities and Bond Structure

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