Question

A corporation has issued 8% AA rated sinking fund debentures at par. Three years later, similar issues are being offered in the primary market at 7%. Which are TRUE statements about the outstanding 8% issue?

(I) The current yield will be higher than the nominal yield

(II) The current yield will be lower than the nominal yield

(III) The dollar price of the bond will be at a premium to par

(IV) The dollar price of the bond will be at a discount to par


(A) I and III

(B) I and IV

(C) II and III

(D) II and IV

Answer 1

C. II and III

Step-by-step explanation:

The bond was issued with a coupon of 8%. Currently, yield for a similar issue is 7%. Therefore, interest rates have fallen subsequent to the issuance of the bond; or the credit quality of the bond has improved.

When interest rates fall, yields on bonds already trading must also fall. What causes this is a rise in the dollar price of the issue - the bond now trades at a premium.