THIRTY YEARS AGO, bonds were quoted by coupon and yield to maturity, with the latter widely regarded as a de facto total return expectation.
As the bond world evolved, new types of bonds like callables, putables, and later, mortgage-backed securities were invented. This caused a dilemma for investors who were not exactly sure how to measure the risk and return of the new instruments. Or, as a fixed-income investor back in the 1980s might have put it: “Those bonds I purchased in the late 1970s sure paid a wonderfully high coupon, but just when rates went down, the bond was called away, and now I have to reinvest at much lower yields. I wish I could put a value on the option that the issuer retains, to redeem the bonds at par.”
The race ...