|
Bond investors
are faced with reinvestment risk -- the threat that if interest rates
fall, the interest payments and principal that investors receive will have to be
reinvested at lower rates. This is important because the yield-to-maturity
calculation we discussed earlier assumes that all payments received are
reinvested at the exact same rate as the original bond's coupon rate.
However, this is rarely the case. As a result, brokers and portfolio
managers try to account for reinvestment risk by calculating a bond's
duration -- the number of years required to recover the true cost of a
bond, considering the present value of all coupon and principal payments
received in the future. Duration can be used to compare bonds with
different issue and maturity dates, coupon rates, and yields to maturity.
The duration of a bond is expressed as a number of years from its purchase date.
|
