You are considering two bonds. Bond M has a 11% annual coupon while Bond N has a
ID: 2789579 • Letter: Y
Question
You are considering two bonds. Bond M has a 11% annual coupon while Bond N has a 8% annual coupon. Both bonds have a 9% yield to maturity, and the YTM is expected to remain constant. Which of the following statements is CORRECT?
The price of Bond N will decrease over time, but the price of Bond M will increase over time.
The prices of both bonds will remain unchanged.
The price of Bond M will decrease over time, but the price of Bond N will increase over time.
The prices of both bonds will increase by 7% per year.
The prices of both bonds will increase over time, but the price of Bond M will increase at a faster rate.
The price of Bond N will decrease over time, but the price of Bond M will increase over time.
The prices of both bonds will remain unchanged.
The price of Bond M will decrease over time, but the price of Bond N will increase over time.
The prices of both bonds will increase by 7% per year.
The prices of both bonds will increase over time, but the price of Bond M will increase at a faster rate.
Explanation / Answer
As Bond M' coupon > YTM, it is a premium bond whose price is greater than the par value, while Bond N is a discount bond, whose price is lower than the par value.
Premium bond price will decline over a period of time and discount bond's price will increase over time and both will converge towards the par value of $1,000.
Hence, c is correct.
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