MBIA, Inc., a municipal bond insuring company, has a bond issue that is selling for $80.05 to yield 9.5%. The bond has a coupon rate of 7%, with semiannual payments, and matures in 2025.If interest rates in the economy increase, which of the following statements will be true, all else equal?
I. the nominal yield of the bond will increase.
II. the yield-to-maturity of the bond will increase.
III. the current yield of the bond will increase.

Question

Quizplus · Accepted Answer

Only statements II and III are true. If interest rates in the economy increase, both the bond's yield-to-maturity and its current yield will increase. The bond's yield-to-maturity will increase to reflect current market rates on similar risk investments, and this, in turn, causes the price of the bond to fall. The current yield of the bond is the interest payment divided by the bond price. Since the interest payment does not change with interest, the current yield will increase with the decrease in the bond price. The nominal yield of the bond is the same as its coupon rate, or what it yields when it sells at its par value, and does not change with changes in interest rates in the economy.

MBIA, Inc, a Municipal Bond Insuring Company, Has a Bond Issue