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CA Final · Advanced Financial Management · Security Valuation

Anil buys a 10-year, 8% annual-coupon bond at a price below its par value and plans to hold it to maturity. Which ordering of the bond's yield measures is correct?

For a bond bought at a discount, coupon rate is lowest, current yield is higher because the price is below par, and YTM is highest because it adds the gain on redemption at par. So coupon rate < current yield < YTM.

  1. ACoupon rate < current yield < YTMCorrect
  2. BCoupon rate > current yield > YTM
  3. CCurrent yield < coupon rate < YTM
  4. DCoupon rate = current yield = YTM

Explanation

For a discount bond, the current yield (coupon ÷ price) exceeds the coupon rate since price is below par. YTM exceeds current yield because it also includes the capital gain from the discount being recovered at redemption. So coupon rate < current yield < YTM. The reverse ordering applies to a premium bond.

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