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Series 7 practice questionhardDebt Securities — Corporate Bonds — Scenario

An investor purchases a 20-year, 5% corporate bond at $850. The bond is callable in 10 years at $1,020. Which yield measure should the investor use to evaluate the worst-case return scenario?

  1. ANominal yield
  2. BCurrent yield
  3. CYield to maturity✓ Correct answer
  4. DYield to call
Explanation

Why C — Yield to maturity

For a discount bond (purchased below par), yield to maturity will be lower than yield to call. Since the bond was purchased at $850, if it is called at $1,020, the investor realizes a larger capital gain over a shorter period (10 years), making YTC higher. For discount bonds, YTM represents the worst-case (lower) yield scenario. The general rule is: for discount bonds, YTM is the worst case; for premium bonds, YTC is the worst case.

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