SIE Exam Question 1014: Answer and Explanation

Question: 1014

Which of the following are correct regarding a bond's yield to maturity (YTM)?

(1) The YTM assumes that coupon payments are reinvested at the YTM rate of return for the life of the bond.

(2) When the market rate of interest for the same term and risk is higher than the coupon rate, a discount will be priced into the bond.

(3) Bonds that are riskier will have lower yields to maturity.

(4) The YTM is the internal rate of return for cash flow associated with a bond, including the purchase price, coupon payments, and maturity value.

• A. (1) and (2) only
• B. (3) and (4) only
• C. (1), (2), and (4) only
• D. (1), (3), and (4) only

Correct Answer: C

Explanation:

The yield to maturity (YTM) is the internal rate of return for cash flow associated with a bond, including the purchase price, coupon payments, and maturity value. It assumes that coupon payments are reinvested at the YTM rate of return for the life of the bond. When the market rate of interest for the same term and risk is higher than the coupon rate, a discount will be priced into the bond. Bonds that are riskier will have higher yields to maturity.