Corporate Bond Price Changes as Maturity Approaches

Analyzing Price Changes of Bond X and Bond Y

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Question

Michelle Garcia, CFA, is analyzing two newly issued corporate debt securities for possible purchase by a client. Bond X is a noncallable 10-year coupon bond currently trading at 102.50. Bond Y is a noncallable 10-year coupon bond currently trading at 98.25. Garcia wants to ensure that her client is fully aware of any probable changes in the bonds' values as they approach maturity. Holding interest rates constant, which of the following best describes how each bond's price will change as it approaches maturity?

Answers

Explanations

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A. B. C.

B

To determine how the price of each bond will change as it approaches maturity, let's consider the characteristics of both Bond X and Bond Y.

Bond X is a noncallable 10-year coupon bond currently trading at 102.50. The fact that it is trading above its face value (also known as trading at a premium) implies that its yield to maturity is lower than its coupon rate. As the bond approaches maturity, its price will tend to converge towards its face value, assuming interest rates remain constant. Therefore, the price of Bond X will decrease over time.

Bond Y, on the other hand, is a noncallable 10-year coupon bond currently trading at 98.25. Since it is trading below its face value (also known as trading at a discount), its yield to maturity is higher than its coupon rate. As the bond approaches maturity, its price will tend to converge towards its face value, assuming interest rates remain constant. Consequently, the price of Bond Y will increase over time.

Based on the above analysis, the correct answer is B. The price of Bond X will decrease, and the price of Bond Y will increase as they approach maturity.

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