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Difficulty: HardDebt Securities and Bond Structure

A fixed-income portfolio manager reviews a $1,000\$1,000 par value corporate bond trading in the secondary market at $1,120\$1,120. The bond features a 6.5%6.5\% stated annual coupon and is callable by the issuer in 33 years at par value. Which of the following choices correctly ranks the bond's yield measures 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, yield to maturity, yield to call, nominal yield

Answer

Nominal yield, current yield, yield to maturity, yield to call
For any bond purchased at a premium (market price above par value), nominal yield remains highest because it reflects annual interest relative to par. Current yield is lower because the denominator is higher than par. Yield to maturity is lower still because it accounts for the loss of the premium over the remaining life of the bond. Yield to call is the lowest return measure because the premium loss is compressed into an even shorter time horizon (3 years). Therefore, the sequence starting with nominal yield and ending with yield to call is correct.

Step-by-Step Solution

1
Determine bond purchase relationship relative to par value
Market price ($1,120\$1,120) is greater than par value ($1,000\$1,000), so the bond is trading at a premium.
Establishing whether a bond is at a discount or premium sets the yield hierarchy baseline.
2
Compare Nominal Yield and Current Yield for a premium bond
Nominal Yield (6.5%6.5\%) > Current Yield ($65$1,120≈5.80%\frac{\$65}{\$1,120} \approx 5.80\%).
Current yield divides fixed annual interest by a purchase price that exceeds par value.
3
Evaluate the impact of holding to maturity vs. early redemption (call)
Yield to Maturity reflects loss of the $120\$120 premium spread over the full term, while Yield to Call forces that same $120\$120 premium loss over a shorter 3-year timeframe.
Amortizing a premium over a shorter period reduces annual return more severely, making YTC lower than YTM.
4
Synthesize the complete yield relationship from highest to lowest
Nominal Yield > Current Yield > Yield to Maturity > Yield to Call.
This sequence accurately orders all yield metrics for a callable bond trading above par value.

Key Concept

Yield Hierarchy for Premium Callable Bonds
Estimated Time:2m 0s
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Topics

Debt Securities and Bond Structure

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