If a bond's yield to maturity exceeds its coupon rate, how does the bond trade relative to par?

If a bond's yield to maturity exceeds its coupon rate, how does the bond trade relative to par?

• A. The bond trades at a discount
• B. The bond trades at a par
• C. The bond trades at a premium
• D. The bond price is unpredictable

Answer: (A)

The price of a fixed-rate bond moves inversely with the yields demanded by investors. The yield to maturity is the return you’d earn if you hold the bond to its maturity, given the current price. When the yield required by the market is higher than the bond’s coupon rate, the fixed coupon payments aren’t enough to deliver that higher return unless the price is lowered. So the bond must trade for less than its par value to push the overall yield up to the market level. In other words, the bond trades at a discount. If the yield were equal to the coupon, the price would be at par. If the yield were lower than the coupon, the price would rise above par (a premium). Price level is not unpredictable in this sense; it adjusts to align with the YTM.

The price of a fixed-rate bond moves inversely with the yields demanded by investors. The yield to maturity is the return you’d earn if you hold the bond to its maturity, given the current price. When the yield required by the market is higher than the bond’s coupon rate, the fixed coupon payments aren’t enough to deliver that higher return unless the price is lowered. So the bond must trade for less than its par value to push the overall yield up to the market level. In other words, the bond trades at a discount.

If the yield were equal to the coupon, the price would be at par. If the yield were lower than the coupon, the price would rise above par (a premium). Price level is not unpredictable in this sense; it adjusts to align with the YTM.