Question

One bond has a coupon rate of 5.6%, another a coupon rate of 8.3%. Both bonds pay interest annually, have 6-year maturities, and sell at a yield to maturity of 7.0%.

a) The bond with a coupon rate of 5.6% will have a higher present value.
b) The bond with a coupon rate of 8.3% will have a higher present value.
c) Both bonds will have the same present value.
d) The yield to maturity has no impact on present value.

Answer 1

The yield to maturity (YTM) has a direct impact on the present value of bonds, as it reflects the total expected return and is used as the discount rate to calculate present value, contrary to the statement that YTM has no impact.

Step-by-step explanation:

The question pertains to the impact of yield to maturity on the present value of bonds. The yield to maturity (YTM) reflects the total return expected on a bond if the bond is held until it matures, considering both interest payments (coupon rate) and any capital gain or loss (difference between purchase price and face value at maturity).

If a bond sells for a yield to maturity of 7.0%, it indicates the market's required rate of return for bonds of similar risk and maturity. The yield to maturity has a direct impact on the bond's present value; the present value is calculated by discounting the bond's future cash flows (interest payments and the repayment of the face value) back to the present using the yield to maturity as the discount rate.

Therefore, the statement that "The yield to maturity has no impact on present value" is incorrect. When the market interest rates change, causing the yield to maturity to differ from the bond's coupon rate, it will either increase or decrease the bond's present value to align the bond's yield with the current market yield.