One bond has a coupon rate of 8%, another a coupon rate of 12%. Both bonds pay interest annually, have 10-year maturities, and sell at a yield to maturity of 10%. a. If their yields to maturity next year are still 10%, what is the rate of return on each bond? b. Does the higher-coupon bond give a higher rate of return?

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Mila Tucker

28 April, 20:12

One bond has a coupon rate of 8%, another a coupon rate of 12%. Both bonds pay interest annually, have 10-year maturities, and sell at a yield to maturity of 10%. a. If their yields to maturity next year are still 10%, what is the rate of return on each bond? b. Does the higher-coupon bond give a higher rate of return?

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Boston Frank · Answer 1

The price of 8% bond must be lower than its face value to make the yield to maturity equal to 10%

Similarly, the price of 12 % bond must be higher than its face value to make the yield to maturity equal to 10%

Rate of return is always equal to yield to maturity.

So even if we do not know the face value of bond, we can infer that rate of return must be equal to yield to maturity.

b) Higher coupon rate does not guarantee higher rate of return because higher coupon than the prevailing rate of return in the market pulls down the market price of the bond.