Explain why the total return from holding a bond to maturity will be between the yield to maturity and the reinvestment rate
What will be an ideal response?
The yield to maturity is based upon the coupon payments and the current market value of the bond. The yield to maturity is below (above) the coupon rate if the current market value is above (below) the par value. If one could reinvest the coupon payments at the yield to maturity, then the total return would be the same as the yield to maturity. If you reinvest the coupon payment below the yield to maturity, you earn a total return below from the yield to maturity. To illustrate assume the yield to maturity is 9% and you reinvest at 8%. Then your total return would have to lie between 9% and 8%. Similarly, if you are able to invest above the yield to maturity of 9%, say 10%, your total return will have to lie between 9% and 10%. In either case, it is true to say that your total return from holding a bond to maturity will be between the yield to maturity and the reinvestment rate.
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