Beruflich Dokumente
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Outline
Sources of Return for a Bond Investor Measures of Return/Yield
Nominal Yield Current Yield Yield to Maturity
Impact of Reinvestment Assumption Yield to Maturity for a Zero Coupon Bond Yield to Call and the Yield to Worse Yield Measures of a Portfolio of Bonds Yield Measure for a Floating Rate Security Total Return
Any measure of bond yield should be based on the above three potential sources of return
Nominal Yield
Nominal yield of a bond is the coupon rate on the bond
A bond with 8 percent coupon has a 8% nominal yield Does not consider capital gain or capital loss Does not consider reinvestment income
Current Yield
Current yield relates the annual coupon interest to the current market price of the bond
Considers only coupon interest income Does not consider capital gain or loss Does not consider reinvestment income
Yield to Maturity
Also called the internal rate of return of a bond The interest rate that will make the present value of the cash flows equal to the price (or initial investment) Rate of return promised to an investor if you purchased the bond at the current market price given coupon and maturity of the bond
Yield to maturity will equal the actual rate of return to a bond investor if and only if
The investor holds the bond to its maturity and All interim cash flows in the form of coupon payments are reinvested at the computed yield to maturity
YTM Contd
The YTM takes into account
Coupon interest income Capital gain or capital loss Interest on interest income
For a given YTM and coupon, higher maturity bonds have a high reinvestment risk For a given YTM and maturity, high coupon bonds have a high reinvestment risk
Yield to Call
Usually, bond market participants compute both the yield to maturity and the yield to call for a callable bond and use the lower of the two to price bonds When bonds are trading at or above a specified crossover point, which is approximates the bonds par value plus one years interest, the YTC will normally provide the lowest yield measure
When is the bond issuer most likely to call back callable bonds?
When the bond price rises to the price above par and the computed YTM becomes low enough that it would be profitable for the issuer to call the bond and finance the call by selling new bonds in the market.
Total Return
Why Total Return?
Suppose an investor who has a 5-year investment horizon is considering the following 4-bonds: Coupon Maturity YTM Bond A 5% 3 years 9.0% Bond B 6% 20 years 8.6% Bond C 11% 15 years 9.2% Bond D 8% 5 years 8.0%
Assuming that all the four bonds are of equal credit quality, which is the most attractive to this investor?
Consequently, any of the bonds can be the best alternative, depending upon some reinvestment rate and some future required yield a