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—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. While A (credit upgrade) might increase a bond's price slightly, it doesn't directly cause premium pricing—the coupon-to-market-rate relationship does. 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 3.85%) because it accounts for the $60 loss at maturity when par value is returned. A is incorrect—YTM is the lowest yield for premium bonds. D (yield to call) would be even lower than YTM for this premium bond because it's called at 102 ($1,020), recovering less premium over a shorter period.

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, creating a capital loss that offsets the higher coupon income.

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 capital loss at 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, resulting in a capital loss that 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.