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Difficulty: EasyDebt Securities and Bond Structure

An investor acquires a fixed-income corporate bond in the secondary market at a price below its stated par value. For this discount bond, which of the following yield measures is the lowest?

  1. Nominal yieldAnswer
  2. B
    Yield to maturity
  3. C
    Current yield
  4. D
    Yield to call

Answer

Nominal yield
For any bond purchased at a discount relative to its par value, the yield measures follow a strict hierarchy: Nominal Yield < Current Yield < Yield to Maturity < Yield to Call. Because the annual coupon rate is calculated based on par value, the nominal yield represents the lowest rate of return among all yield measures when buying below par.

Step-by-Step Solution

1
Determine the relationship between market purchase price and par value.
The bond is bought at a discount (Market Price < Par Value).
Purchasing below par increases effective returns above the coupon rate.
2
Compare the yield hierarchy for a bond trading at a discount.
Nominal Yield < Current Yield < Yield to Maturity < Yield to Call.
The nominal yield is fixed relative to par (1,0001,000), while current yield and yield to maturity reflect the lower purchase price and capital growth.

Key Concept

Yield hierarchy for discount bonds
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Topics

Debt Securities and Bond Structure

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