Let’s say I purchase a bond today with a YTM of 6%.
Next month, because of yet another rate hike, the bond now yields 5%.
When calculating my portfolio’s avg. YTM, do I use the purchase YTM of 6% or the current YTM of 5%?
Hi, Firstly it is more likely that when rates increase the yield on your bond now increases (6% to 7%) not decrease (6% to 5%). Rates up, prices down, prices down, yields up.
Rates versus yield positively correlated
rates and yields versus price negatively correlated
You would use the new yields to calculate porttfolio’s avg YTM.
Yes that’s correct. That was my mistake, regarding the change in yield.
The challenge I’m having with this is that I didn’t purchase it at the new price, so why do I care about the yield at this new price? The reduction in price works against me in terms of the capital loss now incurred. Would the increase in yield outweighed this capital loss?
The YTM is based on the current price not historic cost,
If you expect to hold the bond to maturity your expected return will be greater than when you purchased the bond as the coupons can now be re-invested at higher rates.
The balance of which is most important price movement versus re-invesment return depends upon you expected holding period relative to the Macaulay duration.