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FRM Part I · FRM Exam Part I · Applying Duration, Convexity, and DV01

A 5-year annual-pay bond with a 6% coupon and USD 1,000 face value is priced to yield 6%. If the market yield rises to 7%, which statement about the bond's price is correct?

The bond trades at a discount to par. Its 6% coupon is below the new 7% market yield, so discounting its fixed cash flows at the higher rate gives a present value below USD 1,000, reflecting the inverse price-yield relationship.

  1. AIt trades at a discount to par because the coupon is now below the market yieldCorrect
  2. BIt trades at a premium to par because the coupon exceeds the original yield
  3. CIt remains at par because the coupon rate is unchanged
  4. DIt trades at par plus accrued coupon interest

Explanation

A bond's price falls when its yield rises. With the coupon of 6% below the new yield of 7%, the bond's cash flows are discounted at a higher rate than the coupon, so the price is below par (about USD 959.00). The premium option reverses the price-yield relationship.

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