Fixed Income - Diff b/w Yield and reinvestment rate

CFA Level III
#1

I came across this Contingent Immunization Sch question which states the yields will stay the same at 6.5% for six years, however reinvestment rate (for coupons) is 4%. Is it possible to have difference b/w yield and reinvestment rate for a bond? Shouldn’t they be the same? Schweser Q#116827

#2

yield is referring to coupon the coupon yield on the par value of the bond, which stays fixed. But in the marketplace, the rates have dropped, so the reinvestment of the coupons can’t earn 6.5% anymore.

#3

In that particular question, the coupon rate on the bond is 7.6%

#4

A bond’s yield is basically an IRR function, it assumes yields will be reinvested at it’s yield. However, this is not a realistic assumption. This is out of scope for L3, but did I answer your question?

#5

Yeah, I didn’t see the actual question, but bpdulog is exactly right.

#6

I worked it out in my head in the rest room: If you have a bond that pays coupon and matures in 10 years, it is priced under the assumption that the coupons are re-invested in 10 year bonds ( even up to the very last coupon in this bond) and the YTM stays flat forever. Depending on your investment horizon you may: 1. Reinvest for shorter maturity 2. Even get out of the original bond early. So for price , you will use YTM and coupon rate.( you can do this at the beginning and at the end of your horizon which may not be 10 years for a 10year maturity bond) For re-investment of coupon you will choose re-investment rate and time horizon

#7

Never Mind, I see the question posted here: http://www.analystforum.com/phorums/read.php?13,1247139 lets discuss there

#8

yes you got it. Price of the bond using YTM , PMT=coupon and N=whatever the interval Coupon accrual at Reinvestment rate ( just assume zero coupon on this one ) for N=same interval