When buying bonds, longer maturities almost always give you a higher yield. However, during periods of low interest rates, buying a long-maturity bond can be risky. For a given change in market interest rates, the price on longer bonds will fluctuate more than the price on shorter maturities. For example, if interest rates rise .25 percent across the entire yield curve, the price on a 10-year maturity will drop approximately $19 per $1,000 face value -- but the price of a 20-year maturity will drop approximately $30 per bond.
Notes vs. Bonds
A 10-year bond is actually considered a note. It is the longest maturity of the short-to-medium-term debt maturities. Any maturity longer than 10 years is considered a bond. Normally, bonds issued with maturities of 20 years or longer carry provisions that allow them to be refinanced if interest rates decline below their coupon rates.
The 10-year note and 20-year bond are considered part of the traditional yield curve, which consists of the one, three and six-month Treasury bills, the one-year bill, the two-, three-, five-, seven- and 10-year notes and the 20- and 30-year bonds. This means the prices on 10- and 20-year maturities are always quoted in the financial press.
Institutional investment funds such as pension funds, insurance companies, banks, corporations, mutual funds and exchange traded funds (ETFs) have preset rules regarding the maturities of bonds that may be held in their portfolios. Most favor the shorter end of the market, out to five-year maturities or 10-year maturities. Fewer funds are allowed to buy long maturities because of the yield-price sensitivity at those maturities. They carry higher interest rate risk, so money managed for the benefit of others may be restricted from this higher risk unless the fund buys bonds so the maturities match expected outflows of money, as in the case of pension funds.
Risk vs. Reward
The higher yields in the longer maturities compensate for the higher risk. However, the classic question is whether the higher yield is high enough to fully compensate. If you buy a 20-year bond during a period of high interest rates, you may not be locking in that high yield for 20 years because the bond probably has a call provision that lets the issuer buy the bond back from you at par, or its $1,000 face value, if market interest rates decline. So you face the risk of price drops if you hold a low-coupon 20-year bond and you face losing your bond to a call and refinancing if you hold a high-coupon. That is why most investment funds stick to 10-year or shorter bonds.
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