What it means
Governments borrow by issuing bonds with different lives, from a few months to several decades. The longest is called the long bond, and in the United States it is the 30-year bond.
Investors who buy it lend money for three decades in return for regular interest payments and repayment at the end. The long bond is highly sensitive to interest rates.
If rates rise after you buy, newer bonds pay more, so your older bond becomes less attractive and its price falls. Because the payments stretch so far into the future, the price drop for a given rise in rates is larger than for shorter bonds.
The measure of this sensitivity is duration, which is roughly the percentage change in a bond's price for each 1% change in yield. A long bond has a high duration, often well into the double digits, while a two-year bond has a duration near two.
Pension funds and insurers favour the long bond because it matches their long-term obligations. Traders also watch the yield on the long bond for clues about the economy.
A rise in the yield can mean investors expect higher inflation or more government borrowing, while a fall can signal weaker growth or demand for safety. The gap between long and short bond yields is called the yield curve, and it is closely followed.
For companies, the long bond yield is a benchmark for pricing long-term loans and for calculating the present value of distant cash flows. Anyone valuing a pension liability or a long-lived project should understand how it moves.
Prices and yields move in opposite directions, so a rising yield means a falling bond price. Long bonds are also available through futures and exchange-traded funds, which let investors take a view on long-term rates without buying individual bonds.
These products carry their own costs and risks, such as rolling futures contracts or tracking error. Investors should read the fund documents before buying.
In practice
Real-world examples.
Example
A pension fund with obligations stretching 30 years buys $200,000,000 of long bonds. It wants income and repayment dates that match its future payments. A fall in yields increases the value of its bonds, but also raises the present value of its liabilities.
Example
A bond trader expects economic growth to slow and yields to fall. She buys long bonds, which rise most in price when yields fall. If she is wrong and yields rise, her losses will be larger than on shorter bonds. She sets a limit on the size of the position to control the risk.
Example
A corporate treasurer needs to borrow for 30 years to fund a new facility. She checks the long bond yield and adds a credit spread, which is the extra yield investors want for the company's risk. The result guides her target interest rate. She also asks two banks for quotes before deciding.
Formula
Calculation
Approximate price change = - Duration x Change in yield
Assume a long bond has a modified duration of 17. If the yield rises by 0.5 percentage points, the price falls by about 17 x 0.5% = 8.5%. On a holding of $1,000,000, the loss is about $1,000,000 x 0.085 = $85,000. If the yield falls by 0.5 percentage points, the price rises by about 8.5%, a gain of about $85,000. The estimate is approximate and becomes less accurate for large yield moves.Case study
Seen in the real world.
Stonebridge Insurance is an illustrative, fictional insurer that sells annuities, which promise payments to customers for decades. Its investment team held $500,000,000 in 30-year government bonds to match those promises.
When yields rose sharply in one quarter, the market value of the bonds fell by about 9%, which was $45,000,000. The finance team initially feared a crisis, but the actuaries showed that the value of the liabilities had fallen by a similar amount, because they were discounted at the higher rates.
The company's capital position was little changed, and the board kept the strategy. The chief risk officer reported the result to regulators as part of routine monitoring. The story is illustrative, but it shows why the long bond is best judged against the obligations it supports and not in isolation.
Watch out
Common mistakes.
- Assuming government bonds have no price risk, when long-dated ones can fall sharply when yields rise.
- Confusing the coupon with the yield, when the coupon is fixed and the yield changes with the price.
- Treating the long bond as a short-term investment, when it suits holders who can wait.
Questions
People also ask.
Why do long bond prices fall when yields rise?
Because new bonds pay higher interest, so existing bonds must fall in price to offer a competitive return.
Which bond is the long bond?
In the United States it usually means the 30-year Treasury, and in other countries it means the longest benchmark government bond.
Who buys the long bond?
Pension funds, insurers and other investors with long-term obligations buy it, along with traders making a view on interest rates.
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