Horizon Yield: Scenario Analysis Fixed Income Calculation

CFA Level III
#1

I was going over this calculation again in Schweser and am confused by something What exactly is the “horizon yield”? It says on the “*” it is the “required return on the bond in 1 year” on page 19. It mentions in the vignette that the credit spread is about the change but by an unknown amount. What confused me is that in example 8 on page 49 it says that the credit spread starts out at 350 bps, but then declines to 250bps. The Treasury curve is also flat at 8%. The horizon yield used is the 8% + (350bps - 250bps) = 9% So is the value you use for the horizon yield always going to be the Treasury rate + credit spread?

#2

http://www.financetutorials.com/Tourexcerpt2.htm

#3

I read through the link and think I understand the definition. I’m still confused as to why you use the treasury rate + credit spread as the horizon price.

#4

Giving this post a bump as this is also giving me a brain explosion… Can anyone explain the horizon yield as asked by Bradleyz, Good life karma points up for grab here… Thanks in advance for those will the power to unlock this question…

#5

Bradley,

yield is affected by credit spreads too, and horizon yield is the calculation for the given time period.

so this question has given additional clauses which could affect yield other than time to maturity and YTM

remember prices keep changing as we reach maturity and based on shape of yield curve.

so in this question - we were given few more details to consider.

all he is asking is if bond prices change and time horizon is n years, for the given YTM what would be the yield -

PS: I may be incorrect too-so happy to correct myself.

thanks

#6

Hi Enigma101,

Appreciate your feedback. Sorry for my ignorance (my cross to bear), but why wouldn’t we just take the difference in credit spread, in this instance 100 bps, why does the answer key instead add the treasury yield to the 100 bps? Any thoughts? Cheers

#7

can anyone point to where horizon yield is in CFAI curriculum - no idea what that is (not a good thing with 2 weeks to go…)

#8

i think CFAI curriculum did not cover it explicitly as I did not find it anywhere from CFAI curriculum… and I am confused by this too…

#9

This is part of scenario analysis and there should be an example under Fixed Income Part I. I used Schweser notes and there is an example. Horizon yield is assumption of realized yield upon some scenario as purchasing a bond, reinvest coupons, sell the bond etc.

#10

Horizon yield is the yield (IRR) of the security during the given/remaining time horizon.

#11

Wouldn’t you want to know whether it’s covered in CFAI curriculum though? It’s not in the glossary of Fixed Income in CFAI. Sounds like a waste of time to me…

#12

I am not sure that something may appear in Schweser notes only but not in official curriculum. It may be only opposite. Also, this question appears in CFAI EOC (Fixed Income) and I found that in some Portal topic tests.

#13

Can you please reference the question?? I’ve asked before for a reference to CFAI - if you know of a question with horizon yield, help us all out and let us know.

And how would it be the opposite? You think CFAI would not cover a topic in textbooks that is on the exam, that Schweser covers?? That sounds ridiculous to me

#14

Reading: FI Part 1, scenario analysis and also see Example 6 (BB) under classical immunization.

Fixed Income, Part 1. EOC Question 8 for example.

I said it would be opposite, that some material is not covered but Schweser but be the part of official curriculum. It cannot be covered by Schweser but not covered by official material.

And yes, I did not wright curriculum neither am responsible for material. Currently, we are in the same boat so address your frustration to CFAI, not toward me:)

#15

Flashback, my only frustration was regarding material people are quoting from Schweser that is not in CFAI, and me thinking that I missed it or something. I checked those questions you referenced and there’s nothing on " horizon yield". My understanding is this is a concept only in Schweser. #8 is simply a holding period return, and BB Example #6 simply gives a situation where interest rates move up/down therefore affecting your reinvestment rate, and hence your immunization risk/success.

Nothing on “horizon yield”, but maybe Schweser has developed a new term to describe one of the above concepts, I have no idea. This is why I stick with CFAI material, personally. Anyway, no frustration anymore, all the best.

#16

Just made a search in online vitasource. Horizon yield is NOT a new term. It has been mentioned a few times in L1. Nothing in L3 though…

#17

As per L1 Volume 4 Glossary:

Horizon yield

The internal rate of return between the total return (the sum of reinvested coupon payments and the sale price or redemption amount) and the purchase price of the bond.

#18

Seems concept is just differently named in Schweser vs CFAI. This is simple concept and agree is not new.

#19

Lol well we won’t be getting tested on L1 concepts not found in L3 curriculum, ie. they will never ask us for the “horizon yield” on this exam. It does seem like the concept is quite basic and synonymous with IRR/total return concepts, though (I had no knowledge of what horizon yield was and calculated #8 correctly in EOCs)

#20