CFA Practice Question

There are 490 practice questions for this study session.

CFA Practice Question

A three-year, annual-pay, 5% coupon bond with par value $1,000 currently sells for $975. A three-year, annual-pay, deferred coupon bond with a one-year deferral period and a coupon rate of 5% is also available from the same bond issuer.
A. The price of $1,000 par value of the deferred-pay bond is greater than $975.
B. The price of $1,000 par value of the deferred-pay bond is less than $975.
C. The price of $1,000 par value of the deferred-pay bond is equal to $975.
Explanation: The deferred-pay coupon bond promises the same total cash flows, but bondholders have to wait one year to begin receiving the coupon payments.

User Contributed Comments 8

User Comment
Gina but you're also deferring reinvestment risk. i guess that would be only relevant to this question if you knew the development of interest rates.
is that a correct assumption?
spowers Gina, I think so. For a short duration bond, I assume that the reinvestment risk is less of an issue than the lack of a coupon. I had trouble with this, but ultimately decided a zero coupon bond has to dramatically reduce the price of the bond.
johnsk This has nothing to do with reinvestment risk. If the coupon payment is deferred, then the price of the bond is lower.
myanmar you'll get the coupons in a lump sum after 3 years and have then the reinvestment risk.
sevaa1 Who is better off if the coupon payment is deferred? Issuer or borrower? It is always better to have money now rather than later, which means that the issuer gets to hold money for a longer period of time, thus he is better off. As deferred coupon benefits the issuer, this means that the bond is cheaper when selling, i.e. Price will be less.
kamil77 The first bond is trading at discount, so YTM must be higher than 5% (coupon rate). While the deferred 1st year coupon (to be paid out in year 2)of the other bond will be compounded at 5% pa, it will at the same time be discounted at YTM which is > 5%, so its PV is less than PV of a coupon that would be received one year from now.
ChristinaJ BA II Plus calculator: CFo=0, CF1=0, CF2=50, CF3=1050; Interest =5.6, NPV=Price= 936.49 for deferred coupon; B is the correct answer
Shaan23 Making it complicatd for no reason. No calculation and your logic is out there.

As an investor think of time value of money --- Money now is better then later. Think of the extreme case of a SUPER deferred Coupon bond(Complete Discount bond) <-- just making that up for reasoning...A discount bond is a deep discount.
You need to log in first to add your comment.