What is Premium Bond?

A is correct. The bond trades at a premium (104 = $1,040) because its 5% coupon exceeds current market yields of 4.2%. Like all bonds, rising rates would decrease its market value further. B is incorrect because the bond trades at a premium (above par), not a discount. C reverses the yield relationship; for premium bonds, YTM < CY < Coupon Rate. D is incorrect because bonds don't instantly adjust to par when rates change; they gradually converge to par as maturity approaches.

B is correct. A bond trades at a premium when its fixed coupon rate exceeds current market interest rates, making it more valuable than newly issued bonds with lower rates. A credit upgrade (A) can raise a bond's price by lowering the yield investors require, but the price rises above par only if that yield falls below the coupon rate, so the coupon-to-market-rate relationship is the cause. C is incorrect; longer maturity increases duration and volatility but doesn't determine premium/discount status. D (call provision) typically reduces a bond's value since investors face reinvestment risk, making it less likely to trade at a premium.

C is correct. The nominal yield (coupon rate) is always the highest yield for a premium bond. The hierarchy for premium bonds is: Nominal Yield (4.5%) > Current Yield > Yield to Maturity. Current yield = $45 ÷ $1,060 = 4.25%. YTM is lower still (approximately 3.77%) because it accounts for the $60 of premium not returned at maturity. A is incorrect because YTM is below both the nominal yield and the current yield for a premium bond. D (yield to call) would be lower still (about 3.55%), because the $40 of premium lost on a call at 102 ($1,020) is spread over only 5 years.

D is the exception and is therefore correct. Premium bonds do not always provide higher total returns; in fact, their total return to maturity equals current market rates (the YTM), which is lower than their coupon rate. A is true; premium bonds have higher coupons which means lower duration and less price sensitivity compared to discount bonds with similar maturity. B is true; this is the fundamental yield hierarchy for premium bonds (Coupon > CY > YTM). C is true; investors pay above par but receive only par at maturity, so the lost premium offsets the higher coupon income (for tax purposes, a municipal bond's premium must be amortized, so it produces no capital loss).

B is correct (I, II, and IV). Statement I is true: issuers are more likely to call premium bonds because they're paying above-market rates and can refinance at lower rates. Statement II is true: for premium bonds, Coupon Rate > Current Yield > YTM because YTM accounts for the premium lost by maturity, reducing the overall yield below the current yield. Statement IV is true: when a premium bond matures, the bondholder receives only the par value ($1,000), not the premium price they paid, and the lost premium reduces total return. Statement III is false: premium bonds result from market rates falling below the coupon rate, not rising above it. When rates rise above the coupon, bonds trade at a discount.