Examkin

Question

Difficulty: HardDebt Securities and Bond Structure

An investor evaluates a callable corporate bond trading in the secondary market at a price of $1,080\$1,080. The bond has a par value of $1,000\$1,000, an annual coupon rate of 6.5%6.5\%, 12 years remaining until maturity, and is callable in 5 years at par. Which of the following correctly lists the yield metrics for this premium bond in order from highest to lowest?

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

Answer

Nominal Yield, Current Yield, Yield to Maturity, Yield to Call
When a bond is trading at a premium (above par value), the investor pays more than what will be returned at redemption. The stated nominal yield (coupon rate) is fixed based on par, so it is the highest value. The current yield reflects the coupon divided by the higher purchase price, making it lower than the nominal yield. Yield to maturity (YTM) accounts for the annual loss of premium spread over 12 years to maturity, reducing the yield further. Yield to call (YTC) amortizes that same premium loss over a shorter timeframe of 5 years to the call date, resulting in the lowest yield of all. Thus, the correct sequence from highest to lowest is Nominal Yield > Current Yield > Yield to Maturity > Yield to Call.

Step-by-Step Solution

1
Identify the bond's pricing relative to par value
The bond trades at $1,080\$1,080, which is above its $1,000\$1,000 par value, classifying it as a premium bond.
Determining whether a bond trades at a premium or discount sets the direction of all yield relationships.
2
Analyze the impact of a premium price on annual returns
Because the investor pays more than par, the yield metrics decrease as the loss of premium is amortized over shorter or longer time horizons.
Paying a premium reduces effective yield below the fixed annual coupon (Nominal Yield).
3
Establish the complete yield hierarchy for a premium bond
Nominal Yield (Coupon) is highest, followed by Current Yield, then Yield to Maturity (YTM), and finally Yield to Call (YTC), because accelerating the loss of premium to an earlier call date causes the lowest return.
YTC accelerates the premium loss over 5 years rather than 12 years, making it lower than YTM.

Key Concept

Bond yield hierarchy for premium vs. discount bonds
Estimated Time:1m 30s
Rate this question

Topics

Debt Securities and Bond Structure

More questions from this topic