Asked by Karlie Kuang on May 03, 2024
Verified
When pricing bonds, if a bond's coupon rate is less than the required rate of return, then:
A) The holder of the bond is assured of a profit regardless of when the bond is eventually sold.
B) The holder of the bond will realize a capital gain if the bond is held to maturity.
C) The bond sells at par because the required rate of return is adjusted to reflect the discrepancy.
D) The bond sells at a premium if it has a long maturity, a discount if it has a short maturity.
E) The bond sells at a discount if it has a long maturity, a premium if it has a short maturity.
Required Rate
The minimum annual percentage earned by an investment that will persuade the individual or company to invest.
Coupon Rate
Each year's interest percentage provided by a bond, against its nominal value.
Bond Pricing
The determination of the fair price of a bond, taking into account the present value of its future coupon payments and return of principal at maturity.
- Comprehend the link between interest rates and the valuation of bonds, examining the impacts of maturity periods, coupon rates, and yield to maturity.
Verified Answer
ZK
Zybrea KnightMay 06, 2024
Final Answer :
B
Explanation :
When a bond's coupon rate is less than the required rate of return, it means that the bond is offering less interest than what investors demand for the given level of risk. Therefore, to make the bond attractive to investors, it must be sold at a discount (below its face value). If held to maturity, the investor will realize a capital gain because the bond will be redeemed at its face value, which is higher than the purchase price. Choices A, C, D, and E do not accurately describe the relationship between coupon rate, required rate of return, and bond pricing.
Learning Objectives
- Comprehend the link between interest rates and the valuation of bonds, examining the impacts of maturity periods, coupon rates, and yield to maturity.