Friday, June 12, 2009

estimating a bond's Expected holding-period Return

Once the important of market values is recognized, the presence of a new kind of risk becomes obvious. and the idea of truly risk less investment becomes a relative matter .
Assume that an investor is interested in a holding period of five years. What sort of investment would be riskless for these purposes? obviously, one with no default risk, which promises a payment at the end of five years and at no other time.Any other investment will involve some risk. the five year holding period return from a bond that provides semiannual coupon payments will depend on the prices at which such payments can be used to purchase additional units of the bond (or some other instruments). The return on a bond with a maturity in excess of five years. The return on a shorter-maturity bond will depend on the instruments that are available when the proceeds must be reinvested, and their prices at those times.
since bond prices depend in large part on interest rates, this source of uncertainty is sometimes termed interest-rate many cases it is far more important than default risk. Moreover, it makes even U.s. government debt risky, unless there is perfect correspondence between the investor's desire for cash and the payments promised by the bond in question.
interest-rate risk should be incorporated in any analysis of expected holding-period return. for U.S. government securities this requires estimates of possible future interest rates and their associated probabilities. for other securities the likely future differentials for various levels of risk must also be taken into account.

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