Why the long bond bleeds when rates rise
Bonds and rates move inversely, that is a slogan, not an understanding. The real question is why, and why maturity decides how much it hurts.
Rates rise across the market. What happens to the bond in your portfolio?
Its price falls.
Everyone says "inverse relationship." Is that the answer?
That's where most people stop. The interesting part is why it has to fall.
So explain it like I've never seen a bond.
Yours pays a fixed 3%. New bonds pay 5%.
And?
Nobody buys yours at full price when they can get 5% next door.
So the price?
Has to drop until a buyer's total return matches the market.
What's actually moving here?
The coupon is nailed down. The price is the only thing free to move.
So my bond's yield went up because the market yield went up. Same thing?
Careful. Your yield rose because your price fell. Cause runs price to yield, not the reverse.
Now two bonds, same 3% yield. One matures in 2 years, one in 30. Rates rise 1%. Which hurts?
The 30-year. Badly.
Why so much worse?
The short bond traps you at a bad rate for two years. The long one, for three decades.
So more future payments get repriced.
Exactly. That sensitivity has a name: duration.
So duration is just time to maturity?
No. Maturity is one input. Duration measures how much price moves for a change in yield.
What else changes it?
The coupon. A higher coupon returns your money sooner, so it lowers duration.
The line for the exam?
The coupon is fixed, so only price can adjust. And the longer the duration, the harder it falls.
↑ answer it in your head first ↑
Traps
- ⚠ Stopping at "inverse relationship" without the mechanism, the coupon is fixed, so only the price can move.
- ⚠ Confusing yield with price. A higher yield on your existing bond comes *from* a lower price, not the other way round.
- ⚠ Treating duration as time to maturity. It is a sensitivity measure; maturity is only one input to it.