Question

4. [5 Points] Your broker offers you the opportunity to purchase a bond with coupon payments of $80 per year and a face value of $1,000. If the yield to maturity on similar bonds is 7%, will the bond price be greater or less than the face value and why? What is the bond called? If the yield to maturity on similar bonds increases to 9%, what will happen to the bond price?

Answer 1

Par value = $1,000

Coupon payment = $80

Coupon rate = 80/1000 = 8%

Yield to maturity = 7%

Price of this Bond will be greater than its face value. Because there is a relationship between coupon rate , yield to maturity(YTM) and Price of Bond.

• Coupon rate = YTM then Bond's Price = Face value
• Coupon rate > YTM then Bond's Price > Face value
• Coupon rate < YTM the Bond's Price < Face value

Coupon rate of above bond is greater than its yield to maturity thus, Price of Bond will be greater than Face value.

Bond Called: A bond with call provision gives a right to its issuer to Call (redeem) the bond before its maturity. Generally after a call protection period and before maturity date.

If yield to maturity on similar bond increase to 9%, then value of bond would be less than its Face value. Because now YTM is greater than its coupon rate.

Hope it will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.