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All else constant, a bond will sell at _____ when the bond yield is _____ the coupon rate.
A. at par; less than
B. a premium; equal to
C. a discount; lower than
D. a premium; lower than
E. at par; higher than
♦ Relevant knowledge
The cost for the bond will be dependent on the cash flow that the bond will generate and the current interest rates on the market for bonds with similar risk. It is a significant element in the pricing of the bond, determining whether it will be offered at par, with an additional cost or at an inflated price.
The correct answer is Option “D, a premium; lower than”.
Bonds will be sold at a premium if the yield on the bond is lower than the coupon rate. The present value of the bond is the sum of all cash flows over the years. To arrive at present value, the discount rate is the market rate which is the yield to investors. The yield will be lower than the coupon rate, which will result in less discounting. This means that the cash flows’ present value is greater than the premium bond’s par value.