Question

The reinvestment rate assumption contained in the YTM calculation, implies that:

A. The coupon payments are invested that the market rate of return.

B. The coupon payments are invested at the dividend yield.

C. The coupon payments are invested at the current yield.

D. The coupon payments are invested at the yield to maturity.

E. The coupon payments are invested at the required rate of return for the company.

Answer 1

The YTM on the bond consist of coupon income, reinvestment gain and capital gain or loss so when we calculate the yield to maturity on the bond, we assume that the reinvestment rate is equivalent to the YTM on the bond. Hence the correct answer is

(D). The coupon payments are invested at the yield to maturity.

Other options are not correct because most of the time required rate is taken to be equivalent to the YTM and YTM is also taken to be equivalent to the market interest rate however they can also differ.