IS THE FEAR OF INTEREST RATE VOLATILITY OVERRATED? A SIMULATION CASE STUDY OF BONDHOLDERS’ LONG-TERM RETURNS
Journal Title: European Journal of Business and Social Sciences - Year 2013, Vol 2, Issue 9
Abstract
In this article we propose a simple simulation case study with a specific pedagogical objective. Finance students often struggle to fully understand the difference between coupon rate and yield to maturity; they also seem to have difficulty comprehending the reinvestment rate assumption embedded in the bond pricing model. The simulation case discussed in this paper helps students attain a deeper understating of the reinvestment rate assumption and yield to maturity that would help them not only with cognizance of bonds underlying arithmetic but also with comprehension of related topics such as internal rate of return (IRR) in capital budgeting projects. We simulate cash in/outflows of an investor that makes fixed periodic contributions to her one-bond portfolio and liquidates her position after a decade (or a five-year period with semiannual coupon payments). Results suggest that longterm bond investors should not be unduly concerned with interest rate fluctuations for two reasons: first, the dollar costaveraging nature of steady contributions mitigates the downside risk; second, the opportunity to reinvest ‘guaranteed’ interest payments back in the portfolio helps in achieving higher holding period returns. Our simulation results indicate that long-term bond investors would have earned positive returns exceeding the rate of inflation, with the exception of 1971-81 period, regardless of the direction that the yield took in any particular decade. The 1971-81 period however was concurrent with extreme rise in the yield. In July 1981 the yield reached the all-time high of 15.84%. We show that in this decade the inflation-adjusted return is equal to -0.27% which is a small loss in magnitude compared to the gains in other decades.
Authors and Affiliations
Alex Meisami| Judd Leighton School of Business and Economics Indiana University South Bend 1700 Mishawaka Avenue, South Bend IN, USA 46634. *Corresponding author: ameisami@iusb.edu
Keywords
Related Articles
- EP ID EP10333
- DOI -
- Views 316
- Downloads 18
THE RELIGIOUS CONSCIOUSNESS OF YOUTH AS A TOOL OF MODERN MARKETING
The article reveals the question of the religious consciousness of modern youth and the question of the perception of religion as promotional material.
AGGRESSION AND LIFE SATISFACTION AMONG JOB HOLDER STUDENTS (An Explorative Study in Faisalabad, Pakistan)
The existing study was conceded out to know the aggression’s level and satisfaction of life among job holder students. The life satisfaction questionnaire developed by Ed.Diener in (1985) and Buss-Perry scale of agg...
EXOGENOUS AND DIRECT OBSERVABLE FACTORS AFFECTING ATTITUDE – CASE STUDY ON ROMANIAN CAR MARKET
Attitude is the process that influences in the most visible way the actual consumption behavior, considering all consumer behavior processes. Although theorists have studied for the last century how attitude is formed...
AN EVALUATION OF THE RELATIONSHIP BETWEEN PATIENTS’ ADULT ATTACHMENT STYLES OF VETERANS AND THEIR LEVEL OF TRUST IN THEIR PHYSICIANS AT A VETERAN HEALTH CARE SYSTEM
Background: Previous research has demonstrated that trust is a crucial construct in both interpersonal relationships in the healthcare setting and adult attachment (Bartholomew and Horowitz, 1991). Purpose: The...
THE EXTENT TO WHICH HUMAN RESOURCES MANAGERS IN THE KUWAITI INSURANCE SECTOR ARE RECOGNIZING THE MODERN ROLES OF HUMAN RESOURCES MANAGEMENT
This study aims to identify the extent of the realization of human resource managers in the Kuwaiti insurance modern roles witnessed by the human resources management sector. The study included human resource managers...