Answer:
b. coupon bond's yield-to-maturity to decrease.
Explanation:
imagine that you purchased a bond that yielded a 6% annual coupon rate at par value, and it will mature in 10 years. That means that the market rate was also 6%. But if the market rate drops to 4%, now the price of our bond will be:
YTM = {coupon + [(par value - market value)/time]} / [(par value + market value)/2]
4% = {60 + [(1,000 - MV)/10]} / [(1,000 + MV)/2]
0.04 x [(1,000 + MV)/2] = 60 + [(1,000 - MV)/10]
0.04 x (500 + 0.5MV) = 60 + 100 - 0.1MV
20 + 0.02MV = 160 - 0.1MV
0.12MV = 140
MV = 140/ 0.12 = $1,166.67
This means that the price of the bond will increase. This is valid for both coupon yielding bonds and zero coupon bonds.
