I understand the difference is due to steepness in the yield curve, but how is this steepness seeping in? We use CR to find the semi-annual cashflows which is also used to calculate MV weighted average. How does Par value contribute to this steepness or difference
Thank you
It is becuase when you calc McD you do so using the YTM of the cash flows.
When you combined the 3 individual bonds into one set fo cash flows you change the weights of the cash flows with a skew towards the longer part of the yield curve.
For example with the short term bond in isolate all the cash flowes were discounted at 1.3979% but when the 3 binds are combined these cash flows will not be discounted at a higher rate, giving them less weight in the McD calculation.
Here is an example I did with zero coupon bonds
Sorry I think my answer below answered the wrogn question and now I don’t seem to be able to delete it.
An important aspect of the YTM is the re-invesment of the cash flows.
When you combine the bonds you are going to have higher re-nvestment returns. The Par value of the short term bond is going to be re-inevsted at the long end of the yield curve.
When yield curve is upward sloping
Cash Flow yield > Market Weighted - Majorly due to higher rate of interest in the far end of the curve
The below like should help you get some perspective
Perfect, this makes sense. Thank you!
