8.4 The Realized Compound Yield
Definition
The Realized Compound Yield (RCY) is the External Rate of Return (ERR), which will be earned on an equivalent zero-coupon bond, assuming a future reinvestment rate. In contrast, a bond’s YTM can be thought of as the mathematical twin of IRR. That is, if the reinvestment rate is the Y-T-M, the RCY will equal the YTM.
Practice
Find the RCY for the following:
| CPN = .08 | N = 7 yrs. | Semi-Ann. |
| YTM = .10 | Price = 90.101 | REIN = .06 |
Properties of RCY
- If REIN Rate > YTM, then RCY > YTM.
- The difference between the RCY and the YTM is partly a function of the time left to maturity.
Note
Some analysts use the Spot Curve or Implied Forward Rates in order to project future reinvestment rates and profitability. This is useful for lending situations, where the loans must be financed over future periods.
