YTM

CFA Level II Fixed Income
#1

Some basic questions :

  1. When they say “YTM can be a poor estimate of expected return” , they mean the YTM you calculate upon buying the bond (at the buying rate, mentioned coupon and assuming it will be held till maturity)?

  2. why do they say, in an upward sloping curve, that coupons will be reinvested at forward rates? Does this mean the investor would invest the coupons elsewhere at the newer increased rate,?

#2

P.s feels terrible in asking basic questions but it’s been years to L1

#3

Yes.

It’s possible, if interest rates follow pure expectations.

(Note: interest rates rarely follow pure expectations.)

#4

  1. Well then they should call it expected YTM. This is confusing terminology.

  2. if by “reinvested at higher forward rates” , it actually means in newer issuances, why would it count in the calculation of previous Bond’s YTM…(or only the ones reinvested at the same rate aka same bond would count…)

#5

I can see how it could be confusing.

However, note that YTM is an IRR; it’s a discount rate to get to the present value, not a yield projection to get to a future value. I’ve never heard of anyone complaining that IRR is confusing terminology.

This is a controversy in the interpretation of IRRs in general, and YTMs in particular. (Interestingly, I was just talking about this with my investments class last Wednesday.) Some people believe – wrongly, in my opinion – that the reinvestment income on interim cash flows should be considered to be part of the original investment. Others – including yours truly – believe that any cash flows you receive from an investment are no longer invested in that investment, so whatever they earn from that time forward should be considered a new investment, not part of the original investment.

In any case, CFA Institute seems to take the position that the reinvestment of interim cash flows should be considered part of the original investment; therefore, if you want to get full points on the exam, you’d better adopt that view as well (at least on the first Saturday in June).

#6

Haha thanks. I’m glad I clarified. I guess the difference here is that of the perspective. We think of reinvestment/YTM from the perspective of the investor.