Fixed Income: Investment Horizon & Maculay Duration

CFA Level I Fixed Income
#1

Unable to understand the reasoning behind these statements:

  1. When the investment horizon is greater than the Macaulay duration of a bond, coupon reinvestment risk dominates market price risk. The investor’s risk is to lower interest rates.
  2. When the investment horizon is equal to the Macaulay duration of a bond, coupon reinvestment risk offsets market price risk.
  3. When the investment horizon is less than the Macaulay duration of the bond, market price risk dominates coupon reinvestment risk. The investor’s risk is to higher interest rates.

Thanks

#2

Consider two scenarios:

  1. The YTM remains unchanged, and coupons can be reinvested at the current YTM
  2. The YTM makes one instantaneous increase, and the coupons can be reinvested at the new YTM

At the end of a period of time equal to the Macaulay duration, the value of these two portfolios (bond plus coupons plus interest on coupons) will be equal.

Before that time, the second portfolio will be worth less than the first; after that time the second portfolio will be worth more than the first.

Exactly the opposite happens if the YTM makes one instantaneous _ decrease _.

You can set up a simple spreadsheet in Excel to see this.