313.4
4. Assume that a 2-year coupon bond’s price implies a yield-to-maturity of 5% and a 3-year STRIP’s price implies a yield-to-maturity of 7%. Would a 3-year bond with 7% coupons be selling at a discount, premium, or at par? EXPLAIN. (4)
It would be selling at a premium. The overall YTM on the bond will be some average of 5% and the 7%, meaning it will have to be less than 7%. The YTM summarizes all relevant market rates for the bond. Since the bond is offering 7% coupons and the relevant market rates are less than 7%, it will be selling at a premium because its coupons are greater than the coupons that would correspond to the current market rates.