Understanding Yield to Maturity: A Deep Dive into Bond Dynamics

If the current coupon rate on a bond is 6% and the bond is selling at a 5% discount, what is the yield to maturity on the bond?

• A. Higher than 6%
• B. Lower than 6%
• C. Equal to 6%
• D. Uncertain

Answer: (C)

To determine the yield to maturity (YTM) on a bond when it is selling at a discount, it is essential to recognize how YTM is calculated and its relationship with the bond's coupon rate and market price. In this scenario, the bond has a current coupon rate of 6%, meaning it will pay 6% of its face value in interest annually. However, since the bond is selling at a 5% discount, it implies that the bond's market price is less than its face value. When a bond sells at a discount, the YTM will typically be higher than the coupon rate because, at maturity, the bondholder will receive the full face value of the bond, thus benefiting from the difference between purchase price and face value along with the interest payments. Therefore, with the bond selling at a discount and a coupon rate of 6%, the YTM must logically be higher than 6%. This reflects the additional return the investor earns due to buying the bond for less than its face value. The correct answer is that the YTM is higher than 6%, aligning with the principles of bond pricing and yield calculations.

When it comes to investing in bonds, understanding the nuances of Yield to Maturity (YTM) can seem a bit daunting at first. But hang tight, because once you break it down, you’ll see it’s not as complicated as it appears! You know what? Let’s tackle that question regarding a bond with a 6% coupon rate selling at a 5% discount.

First off, let’s clarify some terms. The coupon rate is the annual interest payment you receive based on the bond's face value. In this case, that’s 6%. If you’ve purchased a bond, you’ll feel the pride of receiving consistent payments—like hitting the jackpot of stable returns. But wait, since it’s selling at a discount, which means you’re not paying the full price, what's the catch?

Right here is where the YTM enters the conversation. If a bond sells below its face value—like a cool 5% discount—it implies that the market price you’re paying is less than what you’ll get back at maturity. So, what does that imply about our YTM?

The YTM reflects the total return you can expect if you hold that bond till it matures. Basically, it’s a glorious combination of the coupon payments plus the extra gain you’ll pocket when the bond returns to its face value. Got it? So here’s the kicker: when the market price is lower than the face value (thanks to that discount), the YTM must be higher than the coupon rate, which is 6% in this scenario.

Thinking logically, if you buy low and sell high, you’re bound to get a greater return. Think of it this way: it's like snagging a fantastic deal on a top-notch gadget. You pay less upfront, but when reselling (or in this case, holding until maturity), you get the full value—and you're getting paid during the hold with those lovely interest checks.

So in simpler terms, the answer to the question is that the YTM is indeed higher than 6%. Not only does it reflect the basic principles of bonds and their pricing, but it also aligns with the investor's common sense: the lower the price paid, the higher the potential return.

As you gear up for your financial management practices, keep these concepts close. Bond pricing doesn’t just hide in textbooks—it’s a real-world application you’ll encounter frequently. So whether you’re grasping strategies for your WGU FINC6000 C214 exam or simply wanting to master the art of investment, understanding YTM will give you that competitive edge—all while deepening your love for financial management. So get comfy with those calculations; they’re your allies in navigating the world of bonds!