Limitations of the cash flow yield measure, Financial Management

Bond's potential returns are calculated using measures like Yield to Maturity (YTM) and cash flow yield. Both these measures are not free from shortcomings. The problem with YTM is that we assume that the coupon payments are reinvested at a rate equal to the YTM and the bonds are held up to maturity. By these assumptions, we are ignoring reinvestment risk and interest rate risk. Reinvestment risk is the risk resulting from the fact that interest or dividends earned from an investment may not be reinvested in such a way that they earn the same rate of return as the invested funds that generated them. Interest rate risk is the risk of having to sell a security before its maturity date at a price less than the purchase price. Cash flow yield also ignores reinvestment and interest risk. It assumes that the projected cash flows are reinvested at the cash flow yield and the mortgage-backed or asset-backed securities are held until the final payout based on some prepayment assumption. The reinvestment risk is of utmost importance to mortgage-backed and asset-backed securities as payments from these securities are monthly and both the principal and interest should be reinvested. The assumption that projected cash flow is actually realized may not be true if the prepayment, default and recovery vary from such assumption. 

Posted Date: 9/10/2012 8:08:55 AM | Location : United States







Related Discussions:- Limitations of the cash flow yield measure, Assignment Help, Ask Question on Limitations of the cash flow yield measure, Get Answer, Expert's Help, Limitations of the cash flow yield measure Discussions

Write discussion on Limitations of the cash flow yield measure
Your posts are moderated
Related Questions
Explain the implications of the deviations from the purchasing power parity for countries’ competitive positions in the world market. Answer:  If exchange rate changes satisfy pu

Max Z = 107x1+x2+2x3 Subject to 14x1+x2-6x3+3x4=7 16x1+x2-6x3 3x1-x2-x3 x1,x2,x3,x4 >=0

Due to the complexity of the tasks involved in many projects, communication of responsibility for those tasks is often helped by means of graphical planning techniques.

how to do assignments based on these topics more specifically?

Mutual funds Mutual funds pool resources from a lot of individuals and companies and invest these resources in diversified portfolios of bonds, stocks and money market instrume

What is Cost of Equity Capital? Describe please.

Q. Explain Inventory approach to cash management? This method analysis cash in the same way as engine inventory such that EOQ models may be employed. In such conditions cash

State the impact on profitability of the company Everything you do has an impact on profitability of the company(including drinking ten cups of coffee in a day!). So if you wan

Introduction to financial management: Meaning and defecation of the financial management Finance function Scope and content of financial function Functions and

The Nu-Nu Brothers Inc. (NNBI) has the following capital structure, which it considers to be optional: Debt 25% Preferred Stock 15% Common Equity 60% NNBI''''s expected net income