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Difficulty: EasyDebt Securities and Bond Structure

An investor purchases a corporate bond in the secondary market at a discount to its par value ($920). Which of the following statements correctly describes the relationship between the bond's Yield to Maturity (YTM) and its Nominal Yield?

  1. The Yield to Maturity is greater than the Nominal Yield.Answer
  2. B
    The Yield to Maturity is less than the Nominal Yield.
  3. C
    The Nominal Yield increases automatically as the market price of the bond falls.
  4. D
    The Current Yield is equal to the Nominal Yield regardless of the discounted price.

Answer

The Yield to Maturity is greater than the Nominal Yield.
For a bond trading at a discount (below $1,000 par value), the overall investment return includes both periodic coupon payments and the capital appreciation as the bond converges toward par value at maturity. Therefore, the Yield to Maturity (YTM) will always exceed the bond's Nominal Yield (coupon rate).

Step-by-Step Solution

1
Identify the bond purchase price relative to par value.
The bond is purchased at 920,whichisbelowparvalue(920, which is below par value ( 1,000), making it a discount bond.
Understanding whether a bond is at a discount, par, or premium determines its yield structure.
2
Analyze the yield components for a discount bond.
In addition to annual coupon income, the investor earns a 80capitalgain(80 capital gain ( 1,000 par - $920 purchase price) over the remaining term to maturity.
Yield to Maturity reflects both coupon interest and the annualized capital gain accrued.
3
Determine the yield hierarchy for discount bonds.
Yield to Call > Yield to Maturity > Current Yield > Nominal Yield.
For all discount bonds, YTM is strictly greater than the stated Nominal Yield.

Key Concept

Discount Bond Yield Hierarchy
Estimated Time:45s
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Topics

Debt Securities and Bond Structure

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