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Difficulty: MediumDebt Securities and Bond Structure

An investor is evaluating a 1010-year corporate bond with a stated annual coupon rate of 6%6\% that is currently selling in the secondary market at a premium price of $1,050\$1,050. Which of the following statements correctly describes the relationship among the bond's yields?

  1. The Yield to Maturity is lower than both the Current Yield and the Nominal Yield.Answer
  2. B
    The Yield to Maturity is higher than both the Current Yield and the Nominal Yield.
  3. C
    The Yield to Maturity is equal to the Nominal Yield, but lower than the Current Yield.
  4. D
    The Yield to Maturity is higher than the Current Yield, but lower than the Nominal Yield.

Answer

The Yield to Maturity is lower than both the Current Yield and the Nominal Yield.
When a bond sells at a premium (above par value of $1,000\$1,000), the investor pays more upfront than will be returned at maturity. This capital loss over the remaining term reduces the total return. As a result, the yields follow a strict hierarchy from highest to lowest: Nominal Yield > Current Yield > Yield to Maturity. Thus, the Yield to Maturity is lower than both the Current Yield and the Nominal Yield.

Step-by-Step Solution

1
Identify the relationship between market price and par value.
The market price of $1,050\$1,050 is greater than the par value of $1,000\$1,000, meaning the bond is trading at a premium.
Bond price dynamics dictate how yield metrics compare based on purchase price relative to par.
2
Apply the premium bond yield hierarchy relationship.
For a bond trading at a premium, Nominal Yield (Stated Coupon) > Current Yield > Yield to Maturity (YTM).
An investor paying a premium receives the fixed annual coupon, but amortizes the extra $50\$50 paid over the remaining term to maturity, reducing the overall annual return (YTM) below the current yield.
3
Select the choice matching this yield order.
The Yield to Maturity is the lowest of the three yields, making it lower than both Current Yield and Nominal Yield.
This directly aligns with standard fixed-income yield relationships for premium bonds.

Key Concept

Bond Yield Hierarchy for Premium Bonds
Estimated Time:1m 15s
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Topics

Debt Securities and Bond Structure

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