A customer purchased a 5.00% coupon corporate bond at 98. The bond pays interest semiannually and is now trading at par. What is the bond's current yield?
The bond's current yield is 5.00%.
Current yield is calculated by taking the bond's annual interest payment and dividing it by its current market price. Since the bond is trading at par (100), the current yield equals the coupon rate of 5.00%, indicating the yield an investor would receive based on the bond’s price and its interest payments.
This choice incorrectly represents the current yield as half of the annual coupon rate. While 2.50% reflects the semiannual interest payment, the current yield must account for the annual total, which is 5.00%.
The figure of 2.55% does not align with the bond’s coupon rate or its market price. To achieve this yield, the bond would need to be trading at a different price or have a different coupon rate, making this option incorrect.
This is the correct answer, as the bond's current yield is directly derived from its coupon rate. With a 5.00% coupon and trading at par, the annual yield remains 5.00%, reflecting the straightforward relationship between coupon rate and current yield when the bond is not discounted or premium priced.
This choice suggests a current yield higher than the bond's coupon rate. For the current yield to be 5.10%, the bond would have to be trading at a discount greater than its coupon rate, which contradicts the information given that it is currently trading at par.
In summary, the current yield of a bond is a key measure of an investor's return based on the bond's coupon rate and market price. In this case, the bond’s coupon rate of 5.00% matches its current yield since it is trading at par value. Consequently, understanding these concepts is essential for evaluating bond investments effectively.
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