Question

We compare two Treasury bond with the same coupon rate and face value. The first Treasury bond is a ten-year bond that was issued five years ago. The second Treasury bond is a newly-issued bond with five years to maturity. Based on historical data, would you expect the first bond to trade at the same yield as the second one? Explain your answer.

Answer 1

Short term bonds (usually upto a maturity of 5 years), generally have low risk and low yields whereas longer-term bonds (maturity of more than 5 yeas), generally have higher yields along with greater risk. Due to longer maturity term of long term bonds, there is a higher chance for interest rate movements to affect the bond’s price. And as interest rates increase, bond prices fall and vice versa.

Generally all the bonds with a maturity of more than one year are exposed to the risk of price fluctuations arising from interest rate movement. The longer the time until maturity, the larger the potential price fluctuations and shorter the time until maturity, the lower the price fluctuation.

In the given situation, since Treasury bonds are involved, there is virtually no risk other than the interest rate risk. Hence, the first Treasury bond, a ten-year bond that was issued five years ago would have same yield as the second Treasury bond, which is a newly-issued bond with five years to maturity because both bonds now have same time to maturity i.e 5 years and if their coupon rates and face values are same, then their yield would also be same