Yield to Maturity

[notjusttp]

I went thru the discussions on Spot rates, Forward rates and Yield to maturity of a bond and wanted to be clear on following points

1) Practically how would these concepts help me if i were to be an investor or a risk manager.

2) YTM conceptually is just the rate which would equate the Cash flows of my instrument to the price and if my coupon rate> YTM then bond will sfor more than par...But logically this would then take the current price of the instrument to a higher price which when compared to PV of cash flows should give me the YTM which would then equal to the coupon on my instrument..so how does this concept help me practically?

3) :smirk: Futher the pull to par effect states that its a gradual process a function of expiry to maturity...however does the competitive forces in marked allow the bond to slowly and gradually decay...practically does not seem correct.

Kindly clarify on these points.

Best Rgds

 

[David Harper CFA FRM]

Hi notjusttp,

1. I'm not sure where to go with this, did i make any claims to practicality Seriously, my humble opinion: the spot rate curve is important (i think) because it summarize the current market's view of interest rates (and the associated views, based on your opinion of the term structure). Forward rates turn out to be more useful than spot rates for advanced duration-type metrics. IMO, the advantage of the yield (YTM) is sheer convenience: one number.

2. I don't really follow, sorry. There may not be a practicality here. The way I look at this is, merely: if your yield < coupon (e.g., 4% yield < 6% coupon) then paying full par for 6% coupons gives you too much return; you have to pay higher and experience capital depreciation of about ~2% to net a competitive return of 4%. Something like: 4% is fair, but my coupons pay 6%, so i will have to "overpay" the par by about 2% to the competitive yield of 4%

3...and the above is much related to pulled to par. if the coupon is 2% and yield is 5%, the bond must be discounted because the other ~3% must come from capital appreciation (roughly 5% yield = 2% coupon income + 3% capital appreciation). So today's price must be discounted, but the "capital appreciation" manifests as pull to par.

David