Question

Compare the prices that you bought and sold the zero coupon and coupon bonds. For both bonds you have made a ________ for the zero coupon bond it is _________/bond for the coupon bond it is ________/bond. This is because YTMs have ______thus pushing up the bond price from the time you bought and allowing you to make such a capital ______(hint: review the relationship between YTM vs Price from the lecture slides. Understand how this translates to bond prices moving and how capital gain and loss can be made as YTM shifts over time)

Answer 1

For both zero coupon and coupon bonds, a decrease in YTM has led to a capital gain upon sale. The bondholder benefits from the inverse relationship between bond prices and YTMs. Consequently, selling the bonds at a higher price than the purchase results in a capital gain.

Step-by-step explanation:

When comparing the prices at which you bought and sold the zero coupon and coupon bonds, for both bonds you have made a capital gain. For the zero coupon bond, the capital gain is certain dollars per bond, and for the coupon bond, it is also certain dollars per bond. This occurs because the Yield to Maturity (YTM) have decreased, causing an inverse relationship with bond prices that increased from the time of purchase, thus allowing you to make a capital gain.

Bond yield reflects the rate of return a bond is expected to pay at the time of purchase. A bondholder is someone who owns bonds and receives the coupon payments. When YTMs decrease, bond prices increase, especially for bonds issued at higher interest rates, and this leads to a capital gain when the bonds are ultimately sold.

For example, if the market interest rates decrease, a bond with a fixed coupon rate becomes more valuable, hence its price goes up. Consequently, if you sell the bond at this higher price, you realize a capital gain.