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Difficulty: MediumDebt Securities and Bond Structure

An investor purchases a 10-year corporate bond trading at a secondary market price of 1,080.Thebondhasaparvalueof1,080. The bond has a par value of 1,000, carries a stated annual coupon rate of 6.00%, and is callable in 5 years at par. Which of the following correctly ranks the bond's yields from lowest to highest?

  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 premium (1,080marketpricevs.1,080 market price vs. 1,000 par value), the investor pays more than the principal returned at maturity or call. Amortizing this premium reduces the yield. The earlier the bond is redeemed, the faster the premium is written off, making Yield to Call (YTC) the lowest yield. Yield to Maturity (YTM) is slightly higher because the premium loss is spread over 10 years. Current Yield (60/60 / 1,080 = 5.56%) is higher than YTM but less than Nominal Yield (6.00%), establishing the sequence: Yield to call, yield to maturity, current yield, nominal yield.

Step-by-Step Solution

1
Determine the bond pricing status relative to par value.
The bond market price (1,080)isgreaterthanparvalue(1,080) is greater than par value ( 1,000), meaning the bond is trading at a premium.
Bond yield relationships depend directly on whether the instrument trades at a discount, par, or premium.
2
Analyze the impact of premium amortization across yields.
The investor pays 80overpar.Amortizingthis80 over par. Amortizing this 80 premium reduces effective return across all yield measures relative to nominal yield.
Nominal yield remains fixed at 6.00% based on par value.
3
Rank the yield components for a premium bond.
Yield to Call < Yield to Maturity < Current Yield < Nominal Yield.
Yield to call loses the 80premiumovertheshortesttimeframe(5years),givingitthelowestyield.Yieldtomaturityspreadsthelossover10years.Currentyieldreflectscoupondividedbymarketprice(80 premium over the shortest timeframe (5 years), giving it the lowest yield. Yield to maturity spreads the loss over 10 years. Current yield reflects coupon divided by market price ( 60 / $1,080 = 5.56%), which is less than the 6.00% nominal yield.

Key Concept

Yield Hierarchy for Premium Bonds
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Topics

Debt Securities and Bond Structure

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