The current yield tends to overstate a bond's total return when the bond sells for a premium because:
A)The bond's price will decline each year
B)Coupon payments can change at any time
C)Bonds selling for a premium have low default risk
D)Taxes must be paid on the current yield

Question

Quizplus · Accepted Answer

When a bond sells for a premium, the yield to maturity is lower than the coupon rate since the investor is paying more for the bond than its face value. As a result, the bond's price will decline each year to reach its face value upon maturity. Therefore, the current yield (which is based on the annual coupon payment divided by the current market price of the bond) will overstate the bond's total return, as it does not account for the decline in price.

The Current Yield Tends to Overstate a Bond's Total Return