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Homework answers / question archive / Each bond has 10 years until maturity and has the same risk
Each bond has 10 years until maturity and has the same risk. Their yield to maturity (YTM) is 9%. Interest rates are assumed to remain constant over the next 10 years. Label the curves on the following graph to indicate the path that each bond's price, or value, is expected to follow. Based on the preceding information, which of the following statements are true? Check all that apply The bonds have the same expected total return. The expected capital gains yield for Irwin's bonds is negative. Smith's bonds have the highest expected total return. The expected capital gains yield for Irwin's bonds is greater than 12%. If a bond is selling for a price much lower than its par value, it is most likely that the bond is bond?
1. Smith’s coupon rate (6%) is less than its YTM (9%), so it sells at a discount. A discount bond’s current price is below the par value ($1,000) and rises over time until maturity (when its value is $1,000). Therefore, the bottom curve on the graph represents Smith's price over time. Irwin’s coupon rate (12%) exceeds its YTM (9%), so it sells at a premium. A premium bond's current price is above the par value ($1,000) and falls over time until maturity (when its value is $1,000). Therefore, the top curve on the graph represents Irwin’s price over time. Johnson's rate (9%) equals its YTM (9%), so it sells at par. A par value bond's current price equals the par value ($1,000), and it is expected to stay constant over time until maturity. Therefore, the middle curve on the graph represents Johnson’s price over time.
2. statement 1 is true, i.e., A bond’s expected total return is its YTM (9%). These three bonds have the same YTM, so they have the same expected total return.
statement 2 is true , because Irwin’s bonds are premium bonds, so their price is expected to decrease over time. Therefore, the expected capital gains yield on Irwin’s bonds is negative.
3. The bond is likely to be an outstanding bond, i.e., The bond is a debt security, under which the issuer owes the holders a debt and (depending on the terms of the bond) is obliged to pay them interest (the coupon) or to repay the principal at a later date, termed the maturity date. Interest is usually payable at fixed intervals (semiannual, annual, sometimes monthly).
