Statement 1: page 29, cfa book4: 4.1.1.3 Determining target return In general in an upward sloping yield curve, the immunization target rate of return will be less than the yield to maturity because of the lower reinvestment return Statement 2:Page 28, in the Exhibit 8 blue section , second paragraph. If market yields rise, an accumulated value, (total return) will be higher than the target value (target yield) will be achieved. This results because the coupon interest payments can be reinvested at a higher rate than the initial yield to maturity. Ok, so both statements begin with "In general in an upward sloping yield curve, the immunization target rate of return will be less than the yield to maturity’ and If market yields rise, an accumulated value, (total return) will be higher than the target value (target yield) will be achieved Both agree that the market yield is higher than the target yield, great… and it appears that they can agree the yield doesn’t need to be as high as the target… BUT now the second statement says that its because reinvestment rates are higher (makes sense), the first says something about lower reinvestment, which is incongruous for two reasons, it seems lower reinvestment would make the need to target yield to maturity to increase and also since the yield curve is upward sloping, one would expect higher reinvestment rates due to increasing interest rates in the market… What subtlety am I missing?
“BUT now the second statement says that its because reinvestment rates are higher (makes sense),”""" the first says something about lower reinvestment,""" The first statement you refer to states that the immunization target rate of return will be lower due to lower reinvestment. This makes sense. The immunization target rate of return assumes flat term structure. In the “first statement” it references an upward sloping yield curve so with the later terms being invested at a higher rate, it makes sense the YTM would be higher. not sure if this helps, but your question is not 100% clear, you list what the material states and then says the inconsistency lay in the fact that the “first says something about lower reinvestment, which is incongruous” maybe rephrase? or point out a questions
SkipE99 Wrote: ------------------------------------------------------- > “BUT now the second statement says that its > because reinvestment rates are higher (makes > sense),”""" the first says something about lower > reinvestment,""" > > The first statement you refer to states that the > immunization target rate of return will be lower > due to lower reinvestment. This makes sense. The > immunization target rate of return assumes flat > term structure. In the “first statement” it > references an upward sloping yield curve so with > the later terms being invested at a higher rate, > it makes sense the YTM would be higher. > To me it seems that the target rate can be lower, because the coupons can be reinvested at a HIGHER rate but Statement 1 reads "less than the yield to maturity because of the lower reinvestment return " Why is it in an upward sloping yield curve that the reinvestment rates would give you a “lower reinvestment return” ? I though upward sloping meant decreasing bond prices, increasing reinvestment? to me “target rate” means the YTM of the original bond…so if YTM is 7.5% and we purchase at par 7.5% is our “target”, now interest rates increase, so the 7.5% coupons are reinvested at lets say 9% resulting an a YTM greater than the target (or original YTM)
this makes my head hurt… Example 8 on pg 28 illustrates what happens when an insurance companies issues a 5 year liability at 7.5%. They then assume there is an immediate change in market yields. All they say is that if market yields rise after purchasing the 7.5% bond and you hold the bond until maturity to cover the liability, your coupons will be reinvested at the new market rates and this could either end up being a good thing or a bad thing. If market yields rise, you get to reinvest your coupons at a higher rate each period and this increases your total return. Since your target yield would have been achieved at a flat 7.5%, rate movements over this assure you of meeting the target yield and then some. If the market yields decrease after buying the bond, you cannot be guaranteed to hit the target yield and have a lower total return less than target value. “”“to me “target rate” means the YTM of the original bond…so if YTM is 7.5% and we purchase at par 7.5% is our “target”, now interest rates increase, so the 7.5% coupons are reinvested at lets say 9% resulting an a YTM greater than the target (or original YTM)”’ Yes, this is basically correct imo. Why is it in an upward sloping yield curve that the reinvestment rates would give you a “lower reinvestment return” ? Where does it specifically say an upward sloping yield curve gives you a lower rate of return? It says an upward sloping yield curve leads to an immunization target rate of return less than the yield to maturity.
> Where does it specifically say an upward sloping > yield curve gives you a lower rate of return? It > says an upward sloping yield curve leads to an > immunization target rate of return less than the > yield to maturity. Statement 1: In general in an upward sloping yield curve, the immunization target rate of return will be less than the yield to maturity {BOLD ITALICIZE}because of the lower reinvestment return {BOLD ITALICIZE}
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