YTM ASSUMPTIONS

Hello, I am struggling to understnad the some of the assumptions from investing in a fixed rate bond. If the market YTM for the bond, our assumed reinvestment rate, increases after the bond is purchased but before the first coupon date, a buy and hold investors realized return will be higher than the YTM of the bond when purchased. —Does this mean that the investor will get his par value $1000 as well as coupons. The difference being to normal investment is that the interest gained on the reinvestment is higher and therefore you get more money? “If the market YTM for the bond, our assumed reinvestment rate, increases after the bond is purchased but before the first coupon date, a bond investor will earn a rate of return that is lower than the YTM at bond purchase if the bond is held for a short period”- in terms of this one, does it mean that the as price has fallen due to the increase in yield that the total amount gained is the lower sale value plus increased reinvestment interest which is less than amount if the bond was kept the whole way through and YTM stayed the same? thanks

Your bond’s coupons will keep coming (unless the borrower defaults). As the rates go up, if you’re a buy and hold to maturity investor then your coupons will be reinvested at the new higher rate. You’ll get the par value + coupons as usual. But your realized yield will be greater than what it was initially when you purchased the bond. If you’re not willing to hold the bond till maturity, there is a good chance that your realized yield will be lower than what it was initially when purchased since you’d be selling the bond at a lower price then what it was bought for as rates rise. Ytm assumes the bond us reinvested at ytm. That’s why when you but the bond with a 7% yield, it assumes you’re reinvesting coupons @7%. If you hold till maturity, and rates go to 8%, coupons get reinvested at 8% and you get a higher return than 7% which you thought you’d get while you bought the bond. Hope this helps!

Thanks, you cleared it up for me!!!