CFAI Reading 28 Example 8 understand, solution, return, target

Siddimaula

I do not understand solution 2 on immunized target rate of return , any explanation will be greatly appreciated.
TIA

AnalystForum

If the term structure is upward sloping it means that long term maturity rates are higher than short term rates;reinvestment of cash is done on the short-end of the term structure. Hence, reinvestment returns are being invested at lower rates dragging down the target rate vis a vis the YTM. (Why the YTM is higher is for compensation from holding long term bonds and all that level 1 fun stuff). The opposite is true for the inverse scenario.

anshultongia

The target rate of return is the assured rate of return at the beginning of the investment and assumes no change in the term structure. This target return is based on the Yield curve a the point of investment. Naturally, the Yield curve will keep changing, but then the target return then stays the same unless the yield curve is flat.
So lets assume your beginning horizon is at point Y in time. If the curve is upward sloping, then your target return is lower than the YTM because the portfolio will be immunized at lower investment rates.
If the curve is downward sloping, then the portfolio target return is higher than the YTM because it is immunized at higher reinvestment rates.
Hope that help.s

ruchita

I’m confused about the problem # 9. Where is the formula applied here? I’m totally lost here.

RMontgomery

derswap07, what is problem #9?? I was asking example 8, which is quite confusing.