Question

One measure of an investor's total return is called holding period return. The computation includes both income and appreciation and is used for both debt and equity securities. An investor's holding period return would be less than the bond's yield to maturity if

A)the bond was called at a discount
B)the coupons were reinvested at a rate below the yield to maturity
C)the investor purchased a put option on the bond
D)the bond was redeemed at a premium

Answer 1

An investor's holding period return on a bond would be less than the bond's yield to maturity if coupons were reinvested at a rate lower than the original yield to maturity. This accounts for the reduction in total return over the bond's holding period, deviating from the reinvestment assumption used in yield to maturity calculations.

Step-by-step explanation:

An investor's holding period return would be less than the bond's yield to maturity if the coupons were reinvested at a rate below the yield to maturity. This scenario is illustrated by choice B) the coupons were reinvested at a rate below the yield to maturity. The holding period return includes both income from coupon payments and capital appreciation or depreciation of the bond's price. When coupons are reinvested at a lower rate than the original yield to maturity, the total return over the holding period will decrease compared to the yield to maturity expected at the time of purchase.

The concept of yield to maturity is essential in understanding the total expected return of a bond over its entire lifecycle. It is based on the assumption that all coupon payments are reinvested at the bond's yield to maturity. Therefore, any deviation from this reinvestment assumption, such as reinvesting at lower rates, impacts the investor’s actual returns. Conversely, as described in option D), if the bond was redeemed at a premium, it would increase the holding period return compared to the yield to maturity, not decrease it. Options A) and C) are not directly related to the relationship between holding period return and yield to maturity.

Answer 2

An investor's holding period return on a bond would be less than the yield to maturity if the coupons were reinvested at a rate below the yield to maturity. This is because the reinvestment at a lower rate reduces the total compounding effect, therefore diminishing the return below the yield to maturity.

Step-by-step explanation:

An investor's holding period return would be less than the bond's yield to maturity if the coupons were reinvested at a rate below the yield to maturity. The yield to maturity is a comprehensive measure of return that assumes all coupon payments are reinvested at the same yield at which the bond was purchased. However, if the coupons are reinvested at a lower rate, the actual return that the investor realizes over the holding period will be lower than the yield to maturity. This occurs because the compounding effect would be less, hence reducing the total return.

Other influences, like the bond being called at a discount, buying a put option, or the bond being redeemed at a premium, do not necessarily affect the holding period return in comparison to the yield to maturity in the same direct manner as reinvestment rates do.