Question

One year ago, the going rate on bonds was 6% and a client purchased 6% bonds. This year, newly issued bonds are paying a coupon of 7%. The bonds purchased by the customer last year will be trading:

[A] at a discount[B] at a premium[C] at par[D] flat

Answer 1

A) At a Discount

Step-by-step explanation:

When a bond is paying less than on going interest rate, so the bond is trading at discount (less than par value) in order to smoothen the effect of reduced interest rate on offer.

Trading price of the bond is calculated such that yield to maturity* of discounted bond is equal to what is being offered by on the run bonds.

*Yield to maturity is defined as total rate of return on the bond if it is held till maturity and all the payments made as scheduled and reinvested at the same rate offered.