The yield to maturity on a bond is:
I. Above the coupon rate when the bond sells at a discount and below the coupon rate when the bond sells at a premium
II. The discount rate that will set the present value of the payments equal to the bond price
III. Equal to the true compound return on investment only if all interest payments received are reinvested at the yield to maturity

Question

Quizplus · Accepted Answer

All three statements are true. Statement I is true because when a bond sells at a discount, the yield to maturity must be higher than the coupon rate to compensate the investor for purchasing the bond at a lower price. Conversely, when a bond sells at a premium, the yield to maturity must be lower than the coupon rate to reflect the fact that the investor paid more than the face value of the bond. Statement II is true because the yield to maturity is the rate that equates the present value of the bond's cash flows (coupon payments and final maturity payment) with the bond's price. Statement III is true because the yield to maturity is the annual rate of return that an investor would earn if all interest payments received were reinvested at the yield to maturity, so it reflects the compound return on investment.

The Yield to Maturity on a Bond Is