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5y risk free bond with a starting yield of 20% and flat yield curve. Assume you sell it every year after 1 year and buy a new 5y bond. In scenario 1 yield declines 2% per year for ten years. In scenario 2 yield is constant. Which scenario has higher returns after a decade?
Despite the massive drop in rates it's 2, the higher yield eventually beats the gains from duration. Was a bit surprising to me.pic.twitter.com/mipcssd2oJ
Inspired by @choffstein thread here -https://twitter.com/choffstein/status/1445038271579443201?s=20 …
on roll yield or leverage)
A (long) 
...
(I wrote about this back in 2017 too: https://blog.thinknewfound.com/2017/04/declining-rates-actually-matter/ …)the emily “yield” account
the emily day-count
Kinda makes sense when you think of the pension funds and insurance bros gobbling up 30y sovereigns like crazy every time there's a bit of a spike in rates.
What tenor do you think is the flip point where duration and convexity take over?
All for people learning about quirks of Macauley duration and reinvestment risk, but why is scenario 2 return line curved like it's compounding?
Assuming an annual coupon, modified duration ≈ 2.99. So I’d have guessed they would've crossed closer to (2 * 2.99 - 1) = 4.98 years.
I did it with ZCBs so the duration is a bit longer but still doesn’t get it quite right. I’d guess the fact that duration changes a lot over the period throws the approximation off.
It's slope. Not surprising.
I found this a bit more intuitive on logarithmic scale. Shows scenario 2 with constant return, scenario 1 with initial boost from roll but decay with declining yieldpic.twitter.com/yzXO6xOy5j
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