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IAI Actuarial Core Principles · Business Finance · Structure and methods of financing a company

Sundaram Textiles Ltd has issued a 10-year bond with a face value of Rs 1,000 and a coupon of 8% per annum paid annually. Market yields for similar bonds have since risen to 10%. Which statement about the bond is correct?

The bond trades at a discount to face value. Its fixed coupon of 8% is below the 10% yield investors now require, so discounting its cash flows at 10% gives a present value below Rs 1,000. Bond prices and yields move in opposite directions.

  1. AIt trades at a premium to face value because the coupon is positive
  2. BIt trades at a discount to face value because the coupon is below the market yieldCorrect
  3. CIt trades at exactly face value because the coupon is fixed
  4. DIts price is unaffected by market yields until maturity
  5. It trades at a premium because its yield to maturity is below the coupon rate

Explanation

The bond pays Rs 80 a year while new investors require 10%, so the present value of its cash flows at 10% is below Rs 1,000. Its price therefore falls to a discount. Price and yield move in opposite directions, so option 5 reverses the relationship.

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