Final answer:
Bert would be getting a good deal investing in bonds with a coupon rate less than the market YTM, as he would likely pay less than the face value for such bonds. This could potentially lead to a higher total return which includes both interest payments and capital gains. The correct option is a.
Step-by-step explanation:
When Bert considers investing in bonds with a coupon rate that is currently less than the market yield to maturity (YTM), it indicates that the bonds are likely priced below their face value. Considering the relationship between bond prices and interest rates, when the coupon rate is less than the YTM, the bonds can be purchased at a discount.
Hence, Bert would expect to pay less than the face value for the bond. This can be seen as a good deal since he has the chance to purchase the bond at a price lower than its nominal value. For instance, suppose Ford Motor Company issues a five-year bond with a face value of $5,000 that pays an annual coupon of $150.
The interest rate Ford is paying on the borrowed funds would be $150/$5,000 = 3%. If the market interest rate rises from 3% to 4% after a year, the value of the bond will decrease. This is because new bonds are likely being issued with a higher interest rate, making the older bonds with lower rates less attractive unless they are discounted.
Therefore, considering total return, which includes interest payments and potential capital gains, Bert could anticipate getting a higher yield on his investment compared to the bond's original coupon rate if he holds the bond until maturity. The correct option is a.