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

Question

Quizplus · Accepted Answer

The market value of a bond will tend to approach its par value as maturity approaches, assuming the bond's required return remains constant. This is due to the fact that interest payments become a larger portion of the bond's total cash flows as time passes, which increases the present value of those cash flows and pushes the bond price towards its par value. The other statements are not correct. A) The total yield on a bond is derived from the coupon payments and the bond's current market price, not dividends. B) Bonds are typically less risky than common stocks and therefore have lower required returns. C) The risk and yield of corporate bonds are dependent on a variety of factors besides company size, such as credit rating and industry conditions. E) If the Federal Reserve announces an expectation of future inflation, bond prices will generally fall due to the eroding effect of inflation on the purchasing power of the bond's future cash flows.

Which of the Following Statements Is CORRECT