Investors often invoke the following argument for buying long-term bonds despite having a short horizon:

"With a positive yield curve, I want to earn the higher yields offered by longer-maturity bonds. I realize I will need to sell the bond on my horizon date. And I understand that if interest rates rise I will be forced to liquidate and sustain a larger loss than were I to purchase a short maturity bond to match my horizon. But I see no problem. Because if rates do increase, I will simply sell my bond early and then reinvest the proceeds at the higher rate!" 

Okay, let's see: Suppose an investor with a 2-year horizon purchases a 4% coupon, 15-year bond at par. One year later, the yield rises to 5.5%. He sells and reinvests the proceeds at 5.5% until his horizon date. What is the ROR?

An investor with a one-year horizon purchases a 2-year note, 1.75% coupon, at a 1.3% yield. The 1-year interest rate is now 1.1%. What is her (expected) ROR assuming:

a) The sale rice is the same as the purchase price

b) The yield on the horizon is the same as the initial yield

c)  The bond "rides down the yield curve"

d) Given the 1-yr and 2-yr rates as 1.1% and 1.3%, respectively, calculate the implied 1-year rate one year from now. What is her expected ROR using this rate?

 

E.C. An investor with a one-year horizon purchases a 20-year, 3% coupon, U.S. Treasury bond at a 2.5% yield-to-maturity.  Recognizing the semi-annual nature of the bond and the necessary day-count conventions, what is the ROR if the coupon was reinvested at 2% and the bond sold at 2.6%?

Answer rating: 100% (QA)

Analyzing Investor Arguments and Calculating RORs Lets tackle each scenario and calculate the Rate of Return ROR for the different strategies Scenario ... View the full answer