Fixed-income securities can be classified as trading at par, premium, or discount.
Which of the following factors can cause a bond to trade at a premium?
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Select an option above to see an explanation here.
A) A decrease in interest rates can cause a bond to trade at a premium, as its fixed coupon rate becomes more attractive than new bonds issued at lower rates. B) A decrease in the bond's credit rating likely causes the bond to trade at a discount, as investors demand a higher yield to compensate for the increased credit risk. C) An increase in the bond's time to maturity does not directly affect its premium or discount status. D) An increase in the bond's call risk would likely cause the bond to trade at a discount, as investors demand a higher yield to compensate for the risk of early redemption.
What is the primary difference between the yield to maturity (YTM) and the current yield of a bond?
A) Both the YTM and current yield consider the bond's current price. B) Both the YTM and current yield consider the bond's time to maturity. C) Both the YTM and current yield are expressed as a percentage of the bond's current market price. D) The YTM is the total return an investor will receive if they hold the bond until maturity, while the current yield is the annual income an investor receives from the bond.
In the early 1980s, interest rates were historically high, with the Federal Reserve raising rates to combat inflation. As a result, many existing bonds were trading at significant discounts to their par value as investors demanded higher yields to compensate for the increased interest rate risk.
Which of the following risks is unique to fixed income securities, as opposed to equity securities?
A) Market risk is a risk that affects both fixed-income and equity securities. B) Interest rate risk is unique to fixed-income securities, as changes in interest rates can directly impact the value of bonds and other fixed-income investments. C) Credit risk can affect fixed-income and equity securities, as both types of investments are subject to the risk of issuer default. D) Call risk is a risk that affects both fixed-income and equity securities, as both types of investments can be subject to early redemption or repurchase by the issuer.
Suppose an investor purchases a 10-year bond with a par value of $1,000 and a coupon rate of 5%. If interest rates rise and new bonds are issued with a 6% coupon rate, the investor's bond will likely trade at a discount to its par value, as investors will be more attracted to the higher-yielding bonds.
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Example Series 65 Example Practice Question
When rates are high, bonds may sigh, trading at a discount, no lie. But when rates fall, bonds stand tall, premiums paid by one and all.
- Par bond relationship to changes in interest rates: A par bond is a bond trading at its face value. When interest rates change, the price of a par bond will move in the opposite direction of the change in interest rates. - Premium bond relationship to changes in interest rates: A premium bond is a bond trading above its face value. When interest rates change, the price of a premium bond will also move in the opposite direction of the change in interest rates, but the price change will be less dramatic than that of a par bond. - Discount bond relationship to changes in interest rates: A discount bond is a bond trading below its face value. When interest rates change, the price of a discount bond will move in the opposite direction of the change in interest rates, but the price change will be more dramatic than that of a par bond.
- Par bond example: A bond with a face value of $1,000 is currently trading at $1,000. If interest rates increase, the price of this bond will decrease. - Premium bond example: A bond with a face value of $1,000 is currently trading at $1,100. If interest rates decrease, the price of this bond will increase, but not as much as a par bond. - Discount bond example: A bond with a face value of $1,000 is currently trading at $900. If interest rates decrease, the price of this bond will increase more than a par bond.