Question

1. What assumption does yield to maturity make regarding re-investment of coupon payments?

2. In what case would the YTM be different that realized yield to maturity?

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Answer 1

1. Yield to maturity makes an assumption that the coupons are reinvested at the same rate throughout the life of the bond.

2. It is unlikely that the interest rates remain constant for the entire life of the bond, say 10 to 30 years. When the interest rates change, the realized yield to maturity changes. When interest rates drop, we will lose on the interest earned on the coupon payments and when the interest rates rise, we gain from the higher interest earned on the reinvested coupons.

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