Question

Suppose you purchase a bond and right after the purchase, the issuer (the firm) is downgraded. The YTM for that bond will most likely ____

	A.	Increase
	B.	Decrease
	C.	Stay the same

Answer 1

YTM or Yield to Maturity is the total return anticipated on a bond if the bond is held until the end of its lifetime. if the issues is downgraded then the price of the bond will decrease(Market Value < Face value) and as a result the YTM will Increase.

Correct Answer-A

Case	Conclusion
Market Value < Face value	YTM> Coupon rate
Market Value > Face value	YTM<Coupon rate
Market Value = Face value	YTM=Coupon rate

For Example-

Company A issued Bond at Face value $1000 for One year with Coupon rate @10% pa. At the date of issue the Face value = market value , hence Coupon rate = YTM.

if after the issue the Company A is down graded then its bond price will decrease say $900.

now if a investor will buy a bond $900 From the market , then he will receive interest of $100 ($1000*10%) and a redemption value of $1000 in one year and the YTM will be more than 22.22%.

$900(1+YTM) = $1100

=>YTM = 22.22%

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