Question

Which of the following statements is CORRECT? Select one: a. If the Federal Reserve unexpectedly announces that it expects inflation to increase, then we would probably observe an immediate increase in bond prices. b. The total yield on a bond is derived from dividends plus changes in the price of the bond. c. Bonds are generally regarded as being riskier than common stocks, and therefore bonds have higher required returns. d. Bonds issued by larger companies always have lower yields to maturity (due to less risk) than bonds issued by smaller companies. e. The market price of a bond will always approach its par value as its maturity date approaches, provided the bond's required return remains constant.

Answer 1

Answer: e. The market price of a bond will always approach its par value as its maturity date approaches, provided the bond's required return remains constant.

Step-by-step explanation:

The Phenomenon described in option E is known as the PULL TO PAR.

It is the tendency of a bond's price to move towards it's face/ par value as it nears maturity because that is the price that the company will pay the bondholders on maturity.

This means that for example, Premium bonds ( bonds trading at a price higher than their par value) will continually drop until they get to the par value and Discount Bonds (bonds trading at a price lower than their par value) will continually rise until they get to the par value.

This is all dependent however, on a CONSTANT Required Rate of Return.