Longer maturity bonds have greater price risk vulnerable to greater volatility

Longer maturity bonds have greater price risk

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Longer maturity bonds have greater price risk (vulnerable to greater volatility of the price as yields move in the market) – or, some may state this as “interest rate risk,” or, the vulnerability to changes in interest rates, or yields, in the market FIN 300 - Bonds Pt. 2 8
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Maturity (or, Duration) Risk This greater risk (w/longer maturity) is a concern Generally speaking, longer maturity bonds (all else being equal) will offer a higher yield (rate of return) Obviously, the higher yields are attractive – but, they come with a higher risk in that the price is much more volatile You are incurring a risk of having the bond’s price drop, if you need to sell well before maturity FYI - for bond investors, the better way to measure the risk is the “ duration ” of a bond, rather that its maturity The duration of a bond is a truer measure of how long (on average) it takes to receive the cash from a bond – “duration” is a term that you might run into one day FIN 300 - Bonds Pt. 2 9
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Price as Bond Matures As we have seen, change in YTM has a less drastic effect on the price, as the maturity decreases This illustrates another important characteristic of coupon bonds, in particular For a given coupon-paying bond, as the bond moves toward maturity, the bond’s price converges to par (or, face) Note that, in the example, when less time is left on the bond’s life, the price remains closer to par FIN 300 - Bonds Pt. 2 10
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Price as Bond Matures As the bond matures: We are keeping all else the same – so, assume that the YTM stays the same – important! If the bond is trading at a premium (when YTM < coupon rate), then that premium will shrink as maturity approaches – the price converges down to par If the bond is trading at a discount (when YTM > coupon rate), then that discount will shrink as maturity approaches – the price converges up to par FIN 300 - Bonds Pt. 2 11
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Miscellany – Bond Price Quotes Often, bond prices are quoted as a percentage of par For example: 93, 95.5, 98 ½, 102, 101.5, 103 1/16, etc.
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