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 331
- Downloads 18
INSTRUCTIONAL SUPERVISION AND QUALITY ASSURANCE IN SCHOOLS IN NIGERIA
This paper carried out an appraisal of instructional supervision and quality assurance in schools in Nigeria. It looked at the concepts of instructional supervision and quality assurance in schools, prerequisites, adv...
THE ROLE OF CONSUMER HOSTILITY AND CONSUMER ETHNOCENTRISM ON THE INTENTION OF BUYING FOREIGN GOODS: A CASE STUDY ON IRANIAN, TURKISH AND AZERBIJANI CONSUMERS
Having an antipathy to some countries, which stem from land conflicts, economic events, diplomatic, regional and religious conflicts as well as the past or current military relations, is emerging as a mode of thought...
MEASURES TAKEN BY THE D.I.O.C.T. IN VIEW OF COUNTERING CROSS-BORDER CRIME
Cross-border crime stands at the moment as a particular threat to every state of the world, and in order to prevent and counter it, a specialized body was established at a national level, namely the Directorate for In...
THE MARKETING OF SMALL AND MEDIUM ENTERPRISE (SME) PRODUCTS BASED ON FOOD PROCESSING
This study aims to examine the constraints and the method of product marketing for Small and Medium Enterprises (SMEs ) based on food processing in the district of Manjung . The study was conducted among the operators...
SELF-CONCEPT BELIEFS AND EXPECTATIONS OF STUDENTS ENTERING AN ACCOUNTING SCIENCES COURSE
The aim of this research was to investigate the notion of self-concept and the expectations of first year students in an Accounting course offered by a university of São Paulo city. In order to accomplish that, an ex...