Which of the following statements is CORRECT? a. A bond is likely to be called i

Question

Which of the following statements is CORRECT?
a. A bond is likely to be called if its coupon rate is below its YTM.
b. A bond is likely to be called if its market price is below its par value.
c. Even if a bond’s YTC exceeds its YTM, an investor with an investment horizon longer than the bond’s maturity would be worse off if the bond were called.
d. A bond is likely to be called if its market price is equal to its par value.
e. A bond is likely to be called if it sells at a discount below par.

Please, explain why? I asked this question a number of times and every time the answer given was different...Please, help and be accurate.

Explanation / Answer

A bond will be called by a issuer only when its coupon rate is more than the market interest rate or when the bond is trading at premium. The Issuer will not call the bond when the coupon rate in lower than market rate or YTM or when the bond is trading at discount or at par. So statement a. b. d. and e are not valid.

When the YTC exceeds YTM also , an investor with longer investment horizon will be worse off as the earning to him will be less when the bond is called off as he gets interest for lesser periods and also the caiptal appreciation is lost. A bond with longer maturity period tends to have lower YTM and it is quite normal to have YTM less than YTC for such bonds and the longer will be time required for capital appreciation. So an early call will casuse loss of interest and capital appreciation for long term investor though the YTC may be more than YTM during the call back.

So option c is correct.

Related Questions

Navigate

• Browse (All)
• Browse W
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.