Inside the Yield Book by Martin L. Leibowitz & Martin L. Leibowitz & Anthony Bova & Stanley Kogelman
Author:Martin L. Leibowitz & Martin L. Leibowitz & Anthony Bova & Stanley Kogelman
Language: eng
Format: epub
Publisher: Wiley
Published: 2013-03-22T16:00:00+00:00
Long-Term Discount Bonds
Table 3 shows the same calculation for a deep discount bond, a 20-year 4 percent bond selling at about 603/8 to yield 8 percent. The top panel shows total return in dollars from one bond, and the bottom panel translates the same figures on the basis of each $1,000 invested, so that the returns can be compared with the 20-year 8 percent bond in Table 1. Here we find that the variation of total return based on changes in interest-on-interest is also large, but not as large as in the case of the par bonds. This is because the discount (eventual capital gain) is a fixed component of total return that does not vary with future interest rates. When coupon income is a smaller proportion of total return, interest-on-interest must also be a smaller portion of total return. The difference, however, between the par bond and the discount bond is not so large as to provide an absolute guide for selection. If interest-on-interest varies, between 6 percent and 10 percent, the total realized compound yield of the 8 percent bond will vary between 7.07 percent and 9.01 percent, while that of the 4 percent bond will vary between 7.25 percent and 8.85 percent. At lower future rates, the 4 percent bond will yield more than the 8 percent boned because the fixed discount substitutes for some variable interest; at higher future rates the 8 percent bond will yield more than the 4 percent bond because interest-on-interest is a larger component of total return and there is no discount.
TABLE 3 A 4 percent 20-year bond bought at 60.414 to yield 8 percent
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