I am a long-term investor who has been investing since the age of 12. I like low-cost index funds and ETFs and often use options to hedge and/or smooth out my returns. I am fascinated by investing and investing history. I have taken graduate classes in CAPM, forex, and bonds. I am a bit of quant... More

For some reason I was thinking about bond current yield, yield to maturity (YTM), and duration while in the shower. It occurred to me that YTM and duration give a general idea about a bond portfolio they are still only provide a limited perspective.

Consider portfolios A and B below invested in risk-free bonds/risk-free cash.

Portfolio A is has one investment, a zero-coupon bond valued at $100 that pays $110 in 365 days. It has a 10% YTM and a 1-year duration.

Portfolio B has two investments. The first is zero-coupon bond valued at $50 which pays $60.50 in exactly 2 years. The second is $50 in cash currently paying 10% APR. Portfolio B also sports a 10% YTM and a 1-year duration.

In terms of YTM and duration, A and B are identical. However I suspect that one is "better" than the other for a 1-year vs. 2-year horizon. "A" gives a precise return at the end of 1 year. "B" offers an overall lower re-investment risk over a 2-year period.

Without cracking open my old "Investments" textbook, I suspect the intuitive difference I see goes beyond convexity. But I can't put my finger on what that something might be.

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## Quick First Post

Consider portfolios A and B below invested in risk-free bonds/risk-free cash.

Portfolio A is has one investment, a zero-coupon bond valued at $100 that pays $110 in 365 days. It has a 10% YTM and a 1-year duration.

Portfolio B has two investments. The first is zero-coupon bond valued at $50 which pays $60.50 in exactly 2 years. The second is $50 in cash currently paying 10% APR. Portfolio B also sports a 10% YTM and a 1-year duration.

In terms of YTM and duration, A and B are identical. However I suspect that one is "better" than the other for a 1-year vs. 2-year horizon. "A" gives a precise return at the end of 1 year. "B" offers an overall lower re-investment risk over a 2-year period.

Without cracking open my old "Investments" textbook, I suspect the intuitive difference I see goes beyond convexity. But I can't put my finger on what that something might be.

Any takers?

Disclosure:N/A