What it means
When the government needs to borrow for a long period, it sells bonds to investors. A thirty-year Treasury pays a fixed rate of interest, called the coupon, every six months, and returns the face value to the investor when the bond matures.
Investors can buy it at auction or later on the secondary market, where prices change every day. Its yield, which is the return an investor earns at the current price, moves in the opposite direction to the price.
When yields rise, prices of existing bonds fall, and when yields fall, prices rise. Because the maturity is so long, the price of a thirty-year bond reacts much more strongly to interest rate changes than the price of a short-term bond.
The long bond is widely used as a reference point. Mortgage rates, corporate bond yields and pension liability calculations are often compared with it or influenced by it.
Its yield is also read as a signal of what investors expect for long-term growth and inflation. Pension funds and insurers like long bonds, since they have liabilities that stretch many years into the future.
Holding a bond that matures in thirty years helps match the timing of cash coming in and going out. The same feature means the holder is exposed to inflation, which can erode the real value of fixed payments.
Because the bond is considered to have very low default risk, it is often described as a risk-free asset, but that term refers to credit risk only. Price risk remains large, and an investor who has to sell before maturity may receive less than they paid.
Holding to maturity removes that price risk, though it does not remove the inflation risk.
In practice
Real-world examples.
Example
A pension fund with obligations that fall due in 25 to 30 years buys long bonds. The regular interest payments and the final repayment line up with its expected payouts to retirees. The fund reduces the risk that rates will change before the money is needed.
Example
A bank economist tracks the yield on the long bond against the yield on a two-year note. When the long yield rises relative to the short yield, she notes that markets expect stronger growth or higher inflation. She uses the comparison in her quarterly outlook.
Example
A corporate treasurer plans to issue long-term bonds to fund a new plant. She uses the thirty-year Treasury yield as the base rate and adds a credit spread for her company's risk. The sum gives her a working estimate of the coupon.
Formula
Calculation
Semi-annual interest payment = Face value x Annual coupon rate / 2
Suppose an investor buys $100,000 face value of a thirty-year Treasury with a 4% coupon. The annual interest is 100,000 x 0.04 = $4,000, so each six-month payment is 4,000 / 2 = $2,000. Over 30 years there are 60 payments, so total interest is 60 x 2,000 = $120,000. At maturity, the investor also receives the $100,000 face value back, making total cash received 120,000 + 100,000 = $220,000.Case study
Seen in the real world.
Evergreen Life Assurance is an illustrative, fictional insurer that sold annuities promising payments for up to thirty years. The investment director needed assets that would still be paying in three decades, so he bought $50,000,000 of long government bonds with a 4% coupon.
When interest rates rose by one percentage point the following year, the market value of the bonds fell by roughly 17%, or about $8,500,000. At first the board was alarmed, but the investment director explained that the insurer's promises to annuitants had also fallen in present value, because they were discounted at the higher rate.
In this illustrative story, the loss on the bonds was largely offset by a smaller liability, and the insurer continued to receive its coupons of $2,000,000 a year. The lesson was that long bonds are best judged alongside the liabilities they are meant to match.
Watch out
Common mistakes.
- Assuming the bond is risk free in every sense, when its price can fall sharply if interest rates rise.
- Confusing the coupon rate with the yield, which changes as the market price changes.
- Believing the investor must hold the bond for 30 years, when it can be sold at any time on the secondary market.
Questions
People also ask.
How often does it pay interest?
Every six months, in equal instalments based on half the annual coupon.
Why is it called the long bond?
Because it has the longest maturity of the regular Treasury securities and is the traditional benchmark for long-term rates.
Why does its price move so much?
The longer the time to maturity, the more a change in the discount rate affects the present value of all those future payments.
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