1. Sources of Return
a. calculate and interpret the sources of return from investing in a fixed-rate bond;
What are the three sources of return on a fixed rate bond?
1. Receipts of the promised coupon and principal payments on the scheduled dates.
2. Reinvestment income
3. Any capital gains or losses if the bond is sold prior to maturity.
What is reinvestment risk?
Reinvestment risk. Future interest rates may be less than the yield-to-maturity (YTM).
What two factors can affect the degree of reinvestment risk?
1. Maturity - The longer the maturity, the higher the reinvestment risk.
2. Coupon rate - The higher the coupon rate, the higher the reinvestment risk.
What is Market price risk?
If the bond has to be sold prior to maturity, its sale price will be lower if rates are higher.