Alright from what little I have learned so far in my valuation class about bond yield I understand that in order to get the rate of return = to YTM we require: 1) to get the cash flows when promised, 2) Hold it to maturity, 3) be able to reinvest that bond at the original YTM. I don't understand how the 3rd one helps us get the return on the bond that equals the YTM? Can anyone please explain. Thanks a lot everone.
2007-01-17 15:05:48 · 1 answers · asked by Anonymous in Business & Finance ➔ Investing
Your thirs step is ambiguos. You cannot reinvest your bond before maturity unless of course you sell before maturity and reinvest as the interest rate fluctuate, buying when rates are up and selling when rates are down. You can reivnest the coupons if you have large bond exposure. This way you might get not the exact YTM but a rate higher than the coupon rate at maturity.
Reinvestment rate is actually not a bond concept, it is an investment concept like for calculating MIRR or market Internal rate of return.
In bond though reinvestment of coupons are assumed in calculating duration which is used by bond portfolio holders to be hedged for interest rate risk. This duration phenomenon was noticed by Prof. Hicks of Cambridge who was a monetory policy exponent. Later on bond portfolio holders started using it to cover their interest rate risks. Duration is the time period in which the bond investment can be recovered before maturity.
2007-01-19 04:31:38 · answer #1 · answered by Mathew C 5 · 0⤊ 0⤋