Securities Industry Essentials (SIE) ExamKnowledge of Capital MarketsMedium
A client is considering investing in a bond that has a coupon rate of 5% and a par value of $1,000. If similar bonds are currently yielding 6% in the market, what would be the approximate market price of this bond?
- A$1,000
- BBelow $1,000
- CAbove $1,000
- DCannot be determined without the bond's maturity date.
Show answer & explanationAnswer & explanation
Correct answer: B. Below $1,000
When a bond's coupon rate is lower than the prevailing market interest rates (yields), the bond will trade at a discount (below par value). In this case, the 5% coupon is less attractive than the 6% market yield, so the bond's price must fall to offer a competitive yield to new buyers.
Why the other options are wrong
- A. This would be the price if the coupon rate equaled the market yield.
- C. This would be the price if the coupon rate was higher than the market yield.
- D. While maturity date affects the exact price, the relationship between coupon and market yield determines if it's trading at a premium or discount.
Bond Price & Yield Relationship
Bond prices move inversely to interest rates (yields). When market yields rise, bond prices fall, and vice versa. If coupon < market yield, bond trades at discount; if coupon > market yield, bond trades at premium.
- Coupon Rate < Market Yield = Discount.
- Coupon Rate > Market Yield = Premium.
- Coupon Rate = Market Yield = Par.
Memory trick: If your coupon is 'Low', your price will 'Go' low (discount).