The YTMs of three $1,000 face value bonds that mature in 10 years and have the same level of risk are equal.Bond A has an 8% annual coupon, Bond B has a 10% annual coupon, and Bond C has a 12% annual coupon.Bond B sells at par.Assuming interest rates remain constant for the next 10 years, which of the following statements is CORRECT?
A) Since the bonds have the same YTM, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity.
B) Bond C sells at a premium (its price is greater than par), and its price is expected to increase over the next year.
C) Bond A sells at a discount (its price is less than par), and its price is expected to increase over the next year.
D) Over the next year, Bond A's price is expected to decrease, Bond B's price is expected to stay the same, and Bond C's price is expected to increase.
E) Bond A's current yield will increase each year.

Question

Quizplus · Accepted Answer

Since all three bonds have the same YTM, the difference in their price is due to their different coupon rates. Bond A has a lower coupon rate than the YTM, which means that its price is below par, or selling at a discount. Bond B has a coupon rate that is equal to the YTM, which means that it is selling at par. Bond C has a higher coupon rate than the YTM, which means that its price is above par, or selling at a premium. Assuming interest rates remain constant, the prices of Bond B should remain the same until maturity, but the prices of Bond A and Bond C are both expected to increase over time, as their coupon rates are greater than the YTM. Therefore, the correct answer is (C).

The YTMs of Three $1,000 Face Value Bonds That Mature