FI P29

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Not good at FI, please help me understand:
in general, for 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; conversely…
dont understand why lower reinvestment return; the relation between immunization target rate and YTM….
Thanks
 
Please refer to the messages posted under the title of “Anyone else thought FI readings were tough?”
We have had some discussions, but I will like to have comments from anyone else regarding this issue because I am still confused by it.
 
I’ll try…. as you move along the curve, the portfolio’s closer to maturing. With an upward-sloping curve, reinvestment income declines as move closer to maturity (b/c ST rates are lower). Therefore, the target rate of return’s less than YTM (which assumes a constant reinvestment rate).
As a caveat, I’m exhausted. Maybe my explanation is garbage? will re-read & try again tomorrow…
 
If I remember correctly the YTM assumes that coupon payments are reinvested at the YTM rate. This is not a valid assumption is the curve is upward sloping as the coupons will be reinvested at lower rates since shorter maturities will be paying less (definition of upward sloping yield curve).
 
mwvt9 Wrote:
——————————————————-
> If I remember correctly the YTM assumes that
> coupon payments are reinvested at the YTM rate.
> This is not a valid assumption is the curve is
> upward sloping as the coupons will be reinvested
> at lower rates since shorter maturities will be
> paying less (definition of upward sloping yield
> curve).
+1 that’s what I was thinking
 
mwvt09 and artvandalay,
Do you mean that the early coupon payments will be re-inveated at rates “lower than YTM” if the curve is upward sloping ? If so, it seems make sense to me.
 
mwvt09 and artvandalay,
Do you mean that the early coupon payments will be re-invested at rates “lower than YTM” if the curve is upward sloping ? If so, it seems make sense to me.
 
AMC Wrote:
——————————————————-
> mwvt09 and artvandalay,
>
> Do you mean that the early coupon payments will be
> re-invested at rates “lower than YTM” if the curve
> is upward sloping ? If so, it seems make sense to
> me.
Yes.
For example: if you have a liability due in 10 years, and you receive a coupon payment in year 5, it will be reinvested for 5 years at a lower yield since its a shorter maturity.
 
Try to imagine the Yield curve. On the Y axis is the yield amount and the x axis is time. No image that as time passes you are moving LEFT on the x axis. Since this is a upward sloping yield curve (when reading left to right) you are actually getting less yield as move further LEFT on the graph (moving down the slope).
So as our importer/exporter friend has shown, each coupon payment will be reinvested at a lower rate.
Make sense?
 
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