When the market price of a bond is higher than its face value, the equation 'Yield to maturity < Coupon rate' is applicable, indicating investors are willing to pay a premium for the bond due to higher coupon payments, resulting in a lower yield to maturity.
- Assuming the current market price of a bond exceeds its par value, the applicable equation is Yield to maturity < Coupon rate.
- This relationship arises since an investor is willing to pay more than the bond's face value due to the relatively higher coupon payments compared to current market interest rates.
- The yield to maturity represents the total return an investor expects to earn if the bond is held to maturity, factoring in the current market price, coupon payments, and the par (or face) value.
- If the market price is higher than the face value, it implies that the coupon rate is more attractive relative to current yields, and investors are willing to pay a premium, hence reducing the yield to maturity below the coupon rate.
- When interest rates decrease, existing bonds with higher coupon rates become more valuable, leading them to trade at a premium (above face value).
- Conversely, increasing interest rates would result in existing bonds being valued at a discount, trading below their face value.
- Thus, the higher the coupon rate relative to the yield to maturity, the higher the market value of the bond will be over par.
Question:
Assume the current market price of a bond exceeds its par value. Which one of these equations applies?
Multiple Choice
- Yield to maturity < Coupon rate
- Market value < Face value
- Yield to maturity = Current yield
- Market value = Face value
- Current yield > Coupon rate