A fixed-rate bond was originally priced at $100 and paid $5 per year in interest. Currently, the bond is trading at $102.75. What is the impact on the current yield of coupon of the bond as a result of the change in price?
The coupon rate of the bond remains fixed at 5%, as it is based on the bond ' s original par value of $100. The current yield, however, decreases because the bond ' s price has increased to $102.75. Current yield is calculated as:
Current Yield=Coupon PaymentCurrent Price\text{Current Yield} = \frac{\text{Coupon Payment}}{\text{Current Price}} Current Yield = Current PriceCoupon Payment
Given:
Coupon Payment = $5
Current Price = $102.75
Current Yield=5102.75≈4.87%\text{Current Yield} = \frac{5}{102.75} \approx 4.87\% Current Yield = 102.755 ≈ 4.87%
A. The coupon is higher than 5%: The coupon remains fixed at 5%.
B. The current yield is higher than 5%: The current yield is lower than 5% due to the increased price.
D. The coupon is lower than 5%: The coupon does not change with the bond ' s price.
[Reference:CSC Volume 1, Chapter 7, "Bond Pricing – Current Yield Calculation" explains the relationship between price changes and current yield., ]
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