Describe the relationship between the yield to maturity and the coupon rate of a bond
What will be an ideal response?
Answer: The coupon rate only tells a bond buyer what prevailing bond rates were when the bond was originally issued. Bond sellers have to make the coupon rate competitive with the market or the bond will not sell well. After the original bond sale, however, the only function of the coupon rate is to tell you what the annual payment is. The annual payment equals the coupon rate × par (face value). The yield to maturity (YTM), however, accounts for more than just the coupons, and it reflects all the other risks of the bond. The YTM is the market rate, and it changes continuously over time, unlike the coupon rate, which never changes (at least for fixed-rate bonds).
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