Which of the following statements is CORRECT? If a 10-year, $1,000 par, zero cou

Question

Which of the following statements is CORRECT?

If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a 10% yield to maturity, and if interest rates then dropped to the point where rd = YTM = 5%, the bond would sell at a premium over its $1,000 par value.

If a 10-year, $1,000 par, 10% coupon bond were issued at par, and if interest rates then dropped to the point where rd
= YTM = 5%, we could be sure that the bond would sell at a premium above its $1,000 par value.

Other things held constant, a corporation would rather issue noncallable bonds than callable bonds.

Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond.

Explanation / Answer

Answer:

Both the 2nd statements are correct.

i.e. If a 10-year, $1,000 par, 10% coupon bond were issued at par, and if interest rates then dropped to the point where rd
= YTM = 5%, we could be sure that the bond would sell at a premium above its $1,000 par value.

The bond price and market interest rate is inversely are inversely related. When interest rate drops the bonds price rises.

As the bond was issued at par and the interest rate has fallen, the bond would certainly sell at premium.

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