Asked by Sophia Winner on May 06, 2024
Verified
You own a bond that has a 7% coupon and matures in 12 years. You purchased this bond at par value when it was originally issued. If the current market rate for this type and quality of bond is 7.5%, then you would expect:
A) The bond issuer to increase the amount of each interest payment on these bonds.
B) The yield to maturity to remain constant due to the fixed coupon rate.
C) To realize a capital loss if you sold the bond at the market price today.
D) Today's market price to exceed the face value of the bond.
E) The current yield today to be less than 7%.
Coupon
The annual interest rate paid on a bond, expressed as a percentage of the face value or the periodic interest payment made by bond issuers to its bondholders.
Market Rate
The prevailing rate of interest or return available on investments, often referred to in the context of loans or savings.
Capital Loss
The loss incurred when the selling price of an asset is less than the purchase price, reflecting a decrease in the value of the asset.
- Understand the correlation between interest rates and bond prices, focusing on the influence of maturity, coupon rates, and yield to maturity on bond valuation.
- Understand the principle of interest rate risk and the way features such as maturity and coupon rates of a bond affect its vulnerability to fluctuations in interest rates.
Verified Answer
HL
Herber LoureiroMay 10, 2024
Final Answer :
C
Explanation :
EWhen the market interest rate exceeds the coupon rate of a bond, the bond's price falls below its face value, leading to a capital loss if sold at market price (C). Additionally, the current yield, which is the annual coupon payment divided by the bond's current price, increases when the bond's price decreases, but since the bond's coupon rate is fixed at 7% and its price has dropped, the current yield remains at 7%, not less (E).
Learning Objectives
- Understand the correlation between interest rates and bond prices, focusing on the influence of maturity, coupon rates, and yield to maturity on bond valuation.
- Understand the principle of interest rate risk and the way features such as maturity and coupon rates of a bond affect its vulnerability to fluctuations in interest rates.