You own a bond that has a 7% coupon and matures in 12 years. You purchased this bond at par value when it was originally issued. If the current market rate for this type and quality of bond is 7.5%,then you would expect:
A) the bond issuer to increase the amount of each interest payment on these bonds.
B) the yield to maturity to remain constant due to the fixed coupon rate.
C) to realize a capital loss if you sold the bond at the market price today.
D) today's market price to exceed the face value of the bond.
E) the current yield today to be less than 7%.

Question

Quizplus · Accepted Answer

When market interest rates increase above a bond's coupon rate, the bond's market value will decline, resulting in a capital loss if the bond is sold at current market prices. In this case, since the bond was purchased at par and the current market rate is higher than the coupon rate, the bond's current market price will be less than its face value, resulting in a capital loss if sold. The yield to maturity would also be higher than the coupon rate, but it is not relevant to the expectation of a capital loss. The bond issuer is not likely to increase the interest payments because the coupon rate is fixed at issuance. The current yield would also be higher than 7%, not lower. Therefore, the correct answer is choice C.

You Own a Bond That Has a 7% Coupon and Matures