Question about immunization target and reinvestment

[Jones473]

From the book: [content removed by moderator]

Why is it not opposite, an upward sloping yield curve should give higher reinvestment income or…?

[S2000magician]

Suppose that you have a 2-year, annual-pay, 6% coupon bond. The 1-year par rate is 3% and the 2-year par rate is 5%, so your YTM is 5%. If the yield curve remains unchanged, then your next coupon will be invested at only 3% (because there will be only 1 year left to maturity). Thus, your total return will be less than 5%.

[Jones473]

Ok. Thanks a lot S2000Magician.

[S2000magician]

My pleasure.

[Enigma1011]

hi Guys,

Can someone explain me the following:

1. what is more important from an FI Portfolio Manager view-yield or total return of a bond/protfolio?
2. Are there certain circumstances/market conditions which makes bond managers choose yield over return and return over yield?

[Jones473]

@S2000magician

Suppose that you have a 2-year, annual-pay, 6% coupon bond. The 1-year par rate is 3% and the 2-year par rate is 5%, so your YTM is 5%. If the yield curve remains unchanged, then your next coupon will be invested at only 3% (because there will be only 1 year left to maturity). Thus, your total return will be less than 5%.

So the YTM is 5%, but the total return is not as you say it is below 5%. But why does not YTM equal total return in this case, when the par rates do not change from what we know at the beginning?