Page No 29 From CFAI Fixed Income book
Determining target rate of return parageaph 2…In general… Upward sloping yiel curve…
Please explain this paragraph.
This has been discussed a while ago.
YTM is a discount rate, while the [immunization] target rate of return reflects the re-investment arte.
For an upward-sloping yield curve, the received coupons will be re-invested in a lower rate, so the total return will be lower than YTM. The conclusion is opposite for a downward-sloping yiel curve.
For an upward sloping, coupons will be reinvested at a higher rate but for less no of years than the begining time period. Negative Price effect knocks down the overall total return
what rahuls said is the right one.
upward sloping - rates in future are higher than in the past. the reinvestment on coupons is higher - but the price effect - lower price at bond maturity - is HIGHER - and hence total return on the Bond is lower over the investment horizon. Overall you end up with a lower Immunization target rate of return.
Opposite happens in the Downward sloping case. you get lower reinvestment, a higher price effect - and net effect is an overall higher immunization target rate of return.
For a upward-sloping yield curve, how can you re-invest the coupons with a higher rate in a shorter time of period?
upward sloping means rate in the next period is higher than what it was in the previous period.
so any coupon you get is getting reinvested at the higher rate.
The re-investment rate may be higher than the short term rate in the previous period, but it should not be higher than the long term rate. Otherwise, the yield curve should no longer be upward-sloping.
No comment. only you are not right. there is no “long term” and “short term” about it.
yield curve shifting upwards means that the coupons are now getting invested at a higher rate. (instead of the YTM which you had started out with when you decided to immunize).
I would assume the yield curve shape, which is upward sloping, will not change. That is, there will be neither upward shifting nor twisting. “long” and “short” are relative to each other in a term structure.
For example, a 1-year no-callable 10% semi-annual coupon bond is bought at par. YTM=10% and 6-month yield is 5%. The total rate of return will be lower than 10% because the coupon is re-invested in lower rate (only 5%).
Hi Rahul I knew this part that in Upward sloping you are reinvesting at highr rate and price effect and reinvestment effect.
But what I concern about is why it is written…In an upward sloping immunized rate is lower than YTM BECAUSE OF LOWER REINVESTMENT REURN.
pLEASE EXPLAIN ME capital letters part.
Hey guys, this is a L2 question. Can you take a look at upward-sloping curve?
garima
Lower Reinvestment Return is because they are talking total return here.
Got it