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Long term interest rates affecting short term bonds



 
 
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  #1  
Old August 8th 05, 10:58 AM
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Default Long term interest rates affecting short term bonds

Hi,

I am new to the group and have a question related to interest rates
affecting bond prices. I want to know whether the bond price of a
short/long maturity gets affected if the interest rate for its maturity
remains constant but that of a greater maturity decreases or increases

If the interest rate for 5 year bonds was constant while long (greater
than 5)interest rate decreased sharply, would it effect the value/price
of a 5 year zero bond?

I would be grateful if someone could advise me on this.

Thanks,

Subir

  #2  
Old August 8th 05, 05:03 PM
Mark Freeland
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wrote:

Hi,

I am new to the group and have a question related to interest rates
affecting bond prices. I want to know whether the bond price of a
short/long maturity gets affected if the interest rate for its maturity
remains constant but that of a greater maturity decreases or increases

If the interest rate for 5 year bonds was constant while long (greater
than 5)interest rate decreased sharply, would it effect the value/price
of a 5 year zero bond?


I believe that almost by definition the answer would be no (for a
zero). Your hypothesis is that the going rate for a debt payable in 5
years doesn't change. If your bond were to rise or fall in price, then
the rate on the bond would change (higher price resulting in lower yield
to maturity, and vice versa), and the bond yield would mismatch the
market. People would sell such bonds (if the price went up), or buy the
bonds (if the price went down), bringing the price of this one bond back
in line with the rest of the market for 5 year debt.

A coupon bond is different. You can think of that as a series of bonds,
each with a different maturity (the date of each coupon). If shorter
term bonds went up in price (because their rates dropped), then the
price of the corresponding "mini-bond" embedded within your five year
bond would rise as well. That would raise the price of the entire bond.

But it would not be affected if yields of only longer term debt changed
(your hypothesis), since you are assuming that yields for all shorter
term bonds remain fixed.

--
Mark Freeland


 




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