Total euro return

The following illnstration demonstrates this. In what follows, the analysis will be cast in terms of euros. Be sure to keep in mind the distinction between total future euros which are equal to all euros that the bond investor expects to receive (including the recovery of the principal) and the total euro return which is equal to the euros the investor expects to realize from the three sonrces of return, namely, coupon payments, capital gain/loss, and reinvestment income. 

Let s illustrate the distinction between total future euros and total euro return with a simple example. Suppose one invested 100 for 10 years at 7% componnded annually. What are the total future euros that will result from this investment This is nothing more than asking for the future value invested of 100 at 7% for 10 years. The total futnre euros generated are 196.72, as shown below... 

The total future euros of this investment ( 196.72) are comprised of the return of principal 100 and the total interest of 96.72. If we subtract the amount invested ( 100) from the total future euros, the difference is 96.72, which is the total euro return. 

Consider a hypothetical 10-year bond selling at par ( 100) with a coupon rate of 7%. Assume the bond delivers coupon payments aimually. The yield to maturity for this bond is 7%. Suppose an investor buys this bond, holds it to maturity, and receives the maturity value of 100. In addition, the investor receives 10 annual coupon payments of 7 and can reinvest them every year that they received at an annual rate of 7%. What are the total future euros assuming a 7% reinvestment rate As demonstrated above, an investment of 100 must generate 196.72 in order to generate a yield of 7% compounded semiannually. Alternatively, the bond investment of 100 must deliver a total euro return of 96.72. 

Let us partition the total dollar return for this bond into its three components coupon payments, capital gain/loss, and reinvestment income. The coupon payments contribute 70 of the total euro return. The capital gain/loss component is zero because the bond is purchased at par and held to maturity. Lastly, the remainder of the total euro return ( 26.72) must be due to reinvestment income. 

To verify this, this par bond s total euro return of 96.72 is driven by two sources of euro return coupon payments and reinvestment income. Recall from the beginning of the chapter, the reinvestment income can be determined using the future value of an ordinary annuity formula. Accordingly, the future value of 10 annual payments of 7 to be received plus the interest earned by investing the payments at 7% compounded annually is found as follows ... 

Thus, the coupon payments and reinvestment income together are 96.72 which agrees with total euro return from our earlier calculation. The reinvestment income alone is 26.72 ( 96.72 - 70). 

EXHIBIT 26.11 Distribution of YTD Total Return (%) by Ratings in iBoxx Euro Corporate Index... 

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See also in sourсe #XX -- [ ]

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