ST has in issue unquoted 7% debentures which were issued at par and are redeemable in 1 year's time. These debentures cannot be traded. The yield to…

The Yield to Maturity (YTM) represents the total return an investor will receive if they hold the debenture until it matures. The relationship between YTM, coupon rate, and market price is fundamental to bond valuation. When the YTM (5%) is lower than the coupon rate (7%), it signifies that the debenture is trading at a premium. This means its current market value is higher than its par (face) value. An investor pays more for the debenture upfront, which reduces the overall yield they earn over its life, bringing it down from the 7% coupon to the 5% YTM.

A. Tax relief on interest is a benefit to the issuer (ST), reducing their after-tax cost of debt. It does not affect the pre-tax yield (YTM) received by the investor.

B. If the debentures were redeemed at a discount, the investor would suffer a capital loss at maturity. This would necessitate a YTM higher than the coupon rate to compensate, not lower.

C. Redemption at par value is the standard assumption. However, this fact alone does not explain why the YTM is lower than the coupon; it is the premium price paid by the investor that is the direct cause.

1. Brealey

R. A.

Myers

S. C.

& Allen

F. (2020). Principles of Corporate Finance (13th ed.). McGraw-Hill Education. In Chapter 3

Section 3-2

"How Bond Prices Vary with Interest Rates

" the text states: "When the bond is selling at a premium

investors who buy the bond face a capital loss over the life of the bond

so the yield to maturity is less than the current yield. ... In general

if the bond price is higher than face value

the yield to maturity is less than the coupon rate."

2. Berk

J.

& DeMarzo

P. (2017). Corporate Finance (4th ed.). Pearson. Chapter 6

Section 6.1

"Bond Cash Flows

Prices

and Yields

" explains the relationship: "When the bond price is greater than the face value

the bond trades 'at a premium' ... In this case

the yield to maturity must be less than the coupon rate."

3. MIT OpenCourseWare. (2008). 15.401 Finance Theory I

Fall 2008. Lecture Notes

Lecture 4: Debt & Fixed Income

p. 11. The notes explicitly state the pricing relationship: "If C > y

bond sells at a premium (P > F)

" where C is the coupon rate

y is the yield

P is the price

and F is the face value. This directly confirms that a YTM lower than the coupon rate means the price is higher than the par value.