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FRM Part I · FRM Exam Part I · Corporate Bonds

A callable corporate bond with a 6% coupon is trading at a yield-to-maturity of 5.2% and a yield-to-call that is lower than its yield-to-maturity. Which statement best describes the bond's price behavior and the appropriate yield measure?

The bond trades at a premium because its coupon exceeds its yield, so a call is likely. The yield-to-call is lower than yield-to-maturity, making yield-to-worst the conservative measure for the investor.

  1. AThe bond likely trades above its call price, and yield-to-worst (the yield-to-call) is the more conservative measureCorrect
  2. BThe bond likely trades below par, and yield-to-maturity is the most conservative measure
  3. CThe bond is exhibiting positive convexity throughout, so yield-to-maturity should be used
  4. DThe bond is a discount bond, so the issuer will not call it and yield-to-call is irrelevant

Explanation

A coupon of 6% exceeds the yield of 5.2%, so the bond trades at a premium. When the yield-to-call is below yield-to-maturity, the call is likely to be exercised, and yield-to-worst, the lower yield, is the conservative measure. A callable bond also shows negative convexity near the call price, which rules out the third option.

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