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Difficulty: MediumDebt Securities and Bond Structure

An investor purchases a 1,000parvaluecorporatebondinthesecondarymarketatadiscountedpriceof1,000 par value corporate bond in the secondary market at a discounted price of 920. Which of the following correctly ranks the bond's yield measures from lowest to highest?

  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
    Current yield, nominal yield, yield to call, yield to maturity
  4. D
    Yield to maturity, yield to call, current yield, nominal yield

Answer

The correct ranking from lowest to highest yield for a discount bond is Nominal Yield, Current Yield, Yield to Maturity, and Yield to Call.
When a bond is purchased at a discount (below 1,000par),theinvestorreceivesannualinterestpaymentsplusagainatmaturityorcall.Becausethepurchaseprice(1,000 par), the investor receives annual interest payments plus a gain at maturity or call. Because the purchase price ( 920) is below par, Current Yield is higher than Nominal Yield. Yield to Maturity (YTM) accounts for the capital gain up to maturity, making it higher than Current Yield. Yield to Call (YTC) accelerates that capital gain over a shorter timeframe, producing the highest yield. Thus, the correct sequence from lowest to highest is: Nominal Yield < Current Yield < Yield to Maturity < Yield to Call.

Step-by-Step Solution

1
Determine the relationship between market price and par value
Market price (920)islessthanparvalue(920) is less than par value ( 1,000), meaning the bond trades at a discount.
Bond price dynamics dictate specific yield relationships based on discount or premium status.
2
Analyze how discount pricing affects yield metrics relative to nominal yield
Current Yield > Nominal Yield because the fixed annual coupon payment is divided by a smaller denominator (920vs920 vs 1,000).
Current Yield equals Annual Interest divided by Market Price.
3
Evaluate Yield to Maturity (YTM) and Yield to Call (YTC)
YTM incorporates the annualized capital gain from 920to920 to 1,000, making YTM > Current Yield. YTC realizes this gain over a shorter timeframe, making YTC > YTM.
Accelerating the discount gain into a shorter holding period increases the annualized rate of return.

Key Concept

Yield Hierarchy for Discount Bonds
Estimated Time:1m 0s
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Topics

Debt Securities and Bond Structure

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