If yield to maturity and risk factors remain constant over the remainder of a coupon bond’s life, and the bond is trading at a discount today, it will have a:
A)
negative current yield and a capital gain.
B)
positive current yield and a capital gain.
C)
positive current yield, only.
Explanation
A coupon bond will have a positive current yield. It will not have a capital gain because its price will increase toward par along its constant-yield price trajectory as long as its YTM remains constant.
What am I missing here? If the bond is at a discount it will increase to par over the line of the bond. How is there no capital gain (price appreciation)?
There is price appreciation.
However, the discount is amortized over the remaining life of the bond. If the effective rate method is used for the amortization, then, if the YTM remains constant, the book value will always be the market value; i.e., the amortization will exactly match the price increase.
Unfortunately, accounting rules allow that the discount may also be amortized straight-line, in which case, if the YTM remains constant, the book value _ will not _ always equal the market value, so there will likely be a capital gain (unless the bond is held to maturity). The author of that question assumes that you’re using the effective rate method for amortization, but you don’t have to.
Where did you get this question?
I’ll have to look more into this ine. A bit confused. I got the probably from Kaplan Q bank.