Average Effective Maturity
When do the bonds mature in a given portfolio of bonds? Some come due in five years; some in 10; some in 30; some in 18 months...so what's the average? And why would we care?
Well, the more long-dated the bonds, the more volatile they will be as interest rates shift around. Like if a bond coming due pays 5% interest and suddenly the Fed, panicking that inflation is eight minutes away, raises rates 300 basis points and indicates 500 points soon...then bond prices of equivalent risk might rocket to yield 10%. At that point, your lousy little five-percenter looks terrible.
The good news? It comes due and pays cash in just six months, so the damage should be minimal. After six months of suffering, you have your cash back and can do whatever you want with it. But if you have a 30-year duration or effective maturity bond, then...um...ouch. Not the 50 Shades kind, either. You'll have to suffer an interminably long time before you feel good about your paltry 5% yield in a 10% world.
Related or Semi-related Video
Finance: What are High Yield/Junk Bonds?19 Views
finance a la shmoop. what are high-yield or junk bonds? alright well here are low
yield bonds, you know Apple Microsoft you know, safe secure sleep [charts]
like a baby even for Chicken Little those kind of bonds. the sky is not
falling. all right well here are high-yield bonds Sears you know Toys R
Us aren't they bankrupt already best buy well someday bankrupt ,yeah not safe not
secure, the sky among other things like credit ratings is in fact falling. well [definitions on screen]
why do high-yield bonds yield a lot that is they pay a lot of interest to
investors why do they do that answer because they have to. right but
why why do they have to? well because the bonds are risky either the business is
in danger of dying, or the business has borrowed so much money that it's in [ best buy pictured]
danger of not being able to pay back the loans. that is their operating profit is
just barely enough to pay the interest costs on all the loans they've borrowed
so the risk of default is high and investors demand very high interest for
taking on the risk of having to go through a potential bankruptcy. the term
junk was coined in the 1980s when the now-defunct investment bank Drexel [100 dollar bill]
Burnham Lambert sold boatloads of bonds which had dubious creditworthiness in
weak backing and so the boatloads of bonds sank and ended up as basically
junk. and not the Chinese junk that actually sales, a different kind of junk.
anyway unlike your fancy triple-a bonds which you can see here on this lovely [ boat sails on a lake]
table ,those junk bonds were riskier than us women in shark-infested waters with a
bloody nose. so what's the best way to encourage people to do risky possibly
dangerous things ?well pay them a lot of money. so that's why junk bonds yield
such killer returns for investors because otherwise well these things [two people frown in front of bond store]
would never leave the shelf.
Up Next
What is the maturity of a bond? Maturity refers to the time when an investment ends. When maturity happens, the investor is either on the hook for...
Term to maturity is kind of the life cycle of a bond, but luckily for the bond, it gets to skip puberty.
What are T-Notes, T-Bonds, and TIPS? T-Notes are debt securities (like bonds) that are issued by the government and mature within one to 10 years....
The inverse relationship refers to the fact that as interest rates go up, bond prices go down, and vice-versa. Bottom line reason is supply and dem...