Reinvestment risk for bond selling at*

[FrederickF]

[question removed by admin]

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correct me if i’m wrong. but bonds selling with premium have lower yield right? how come they say that bond selling at a premium has a higher coupon rate? the rest of the explanation i get it. just seems to miss something fundamental here.

 

[adekunle]

The fundmental thing you’re missing is yield isn’t coupon.

 

[FrederickF]

i know yield isn’t not coupon.
Premium bond = yield < current yield < coupon
Discount = yield > current > coupon
but can you throw me some light as to why the premium bond has higher coupon rate?

 

[S2000magician]

If you have two otherwise identical bonds, one with a coupon of 4% and the other with a coupon of 8%, they’ll trade at the same YTM (they’re identical, after all). The latter will have higher reinvestment risk by virtue of its higher coupon: more cash flow to reinvest.

 

[busprof]

Here’s a non-techy explanation (it might or might not help, and I’m sure S2000 will have things to add that I’ve missed
For a discount bond, relatively more of its return comes from capital appreciation (think of a zero coupon as the extreme). This portion of the return has no intermediate cash flows, and therefore no reinvestment risk. In contrast, in a premium bond there is actually capital DEPRECIATION (the price declines over time). So more of its return comes from the coupons. These coupons must be reinvested. So, compared to the discount bond, its return is driven more by the rates at which the intermediate cash flows can be reinvested.