Which bond will have a higher yield to maturity, a $1,000 face value bond, with a 5.0% coupon rate that sells for $900; or a $1,000 face value bond, with a $50 annual coupon that sells for $1,050? Explain your choice.
What will be an ideal response?
The bond that is selling for $900 will. Both bonds have the same coupon rate, 5%, and they have the same maturity, so the bondholder's returns from the coupons are equal. What differentiates the two is that the bondholder who purchases the bond for $900 will also receive a capital gain which increases his/her yield to maturity.
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