An investor purchases a corporate bond with a 1,000 par value in the secondary market at a… — FINRA SIE (Securities Industry Essentials)

An investor purchases a corporate bond with a $1,000 par value in the secondary market at a discounted price of$ 940. Which of the following statements correctly describes the relationship between the bond's nominal yield (coupon rate) and its current yield?

The current yield is greater than the nominal yield.Answer
B
The current yield is lower than the nominal yield.
C
The current yield and nominal yield are equal.
D
The nominal yield will increase automatically to match market interest rates.

Answer

The current yield is greater than the nominal yield.

When a bond is purchased at a discount (below par value of $1,000), the investor receives the same fixed annual interest payment while paying less money upfront. Consequently, the current yield (annual dollar interest divided by current market price) is greater than the nominal yield (coupon rate).

Step-by-Step Solution

Identify the market price condition relative to par value.

The bond is trading at

940, which is below its

1,000 par value, making it a discount bond.

Bond price relationships dictate yield order based on whether the bond trades at par, discount, or premium.

Analyze the formula for current yield:

\text{Current Yield} = \frac{\text{Annual Interest}}{\text{Market Price}}

Dividing the fixed annual coupon payment by a smaller denominator (

940 instead of

1,000) produces a higher percentage yield.

A discount price increases the effective yield return relative to the fixed coupon rate.

Establish the yield hierarchy for a discount bond.

\text{Nominal Yield} < \text{Current Yield} < \text{Yield to Maturity}

For any discount bond, the current yield is always higher than the nominal yield.

Key Concept

Bond Discount Yield Hierarchy

Estimated Time:45s

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