FINRA Series 7Investment Information and Suitable RecommendationsEasy
A client purchases a municipal bond with a 4.5% coupon rate, currently trading at a yield to maturity (YTM) of 4.2%. If the bond has a par value of $1,000 and the client is in the 28% federal tax bracket and 5% state tax bracket, what is the bond's current yield?
- A4.74%
- B4.95%
- C4.20%
- D4.50%
Show answer & explanationAnswer & explanation
Correct answer: A. 4.74%
Current yield is calculated by dividing the annual interest payment by the bond's current market price. Since the YTM (4.2%) is lower than the coupon rate (4.5%), the bond must be trading at a premium. The current market price is implicitly higher than par.
Why the other options are wrong
- B. This calculation is incorrect and does not reflect the relationship between coupon, current yield, and YTM for a bond trading at a premium.
- C. This is the yield to maturity, not the current yield.
- D. This is the coupon rate, not the current yield. The bond is trading at a premium, so its current yield will be lower than the coupon rate.
Current Yield (Bonds)
Current yield measures the annual income (coupon payment) an investor receives from a bond relative to its current market price. It does not consider capital gains or losses if the bond is held to maturity.
- Calculated as Annual Interest / Current Market Price.
- Does not account for bond's maturity or capital gains/losses.
- Higher than YTM if bond is trading at a discount, lower if trading at a premium.
Memory trick: Coupons Pay Market Price Profit.