Securities Industry Essentials (SIE) ExamKnowledge of Capital MarketsHard
A municipal bond is issued with a coupon rate of 4.5% and is currently trading at a premium. If a client purchases this bond, which of the following statements about its yield calculations is TRUE?
- AThe yield to maturity will be higher than the current yield.
- BThe current yield will be higher than the coupon rate.
- CThe yield to call will be lower than the yield to maturity.
- DThe nominal yield will be higher than the yield to call.
Show answer & explanationAnswer & explanation
Correct answer: C. The yield to call will be lower than the yield to maturity.
When a bond is trading at a premium, its yield to call (if callable) will be the lowest of all yield measures because the bond is most likely to be called at the earliest opportunity, resulting in fewer interest payments and a capital loss from the premium.
Why the other options are wrong
- A. At a premium, the yield to maturity will be lower than the current yield (and coupon rate).
- B. At a premium, the current yield (coupon / price) will be lower than the coupon rate.
- D. Nominal yield (coupon rate) is typically the highest for a premium bond, so it would be higher than YTC.
Yields on Premium Bonds
For bonds trading at a premium (price > par), the yields rank from highest to lowest as: Nominal Yield > Current Yield > Yield to Maturity > Yield to Call.
- Nominal Yield (Coupon Rate) is fixed.
- Current Yield considers market price.
- YTM considers capital loss at maturity.
- YTC considers capital loss at an earlier call date.
Memory trick: Premium Bond: 'NCY-TM-TC' (Nicely Timed Call).