Bonds are supposed to be the safe part of a portfolio. Yet in 2022, funds holding long-term U.S. Treasury bonds lost about 30%. Nobody defaulted. What happened?
Learning objectives. After this week you can (1) describe a bond's face value, coupon and maturity; (2) explain why bond prices fall when rates rise and compute a current yield; and (3) use duration to estimate a price change.
Remember this: rates up, bond prices down. Duration tells you how far.
1) Bond anatomy
- Face (par) value: the amount repaid at maturity, classically $1,000.
- Coupon rate: the fixed yearly interest as a percent of face. A 5% coupon on $1,000 pays $50 a year.
- Maturity: when the face value comes back, from months to 30 years.
2) Prices and yields: the seesaw
You hold that 5% bond and new bonds start paying 6%. Nobody will pay full price for $50 a year when $60 is on offer, so your bond's price must fall until it competes. Rates up, existing bond prices down; rates down, prices up.
Current Yield = Annual Coupon ÷ Current Price × 100
A $50 coupon bond trading at $950 has a current yield of 50 ÷ 950 × 100 = 5.26%. Yield to maturity (YTM) is the total yearly return if you hold to the end, counting the coupons and the price's pull back to par. Price below par means YTM above the coupon. An unusually high yield is payment for extra credit risk (the chance the issuer fails to pay) or extra duration.
3) Duration: how hard the seesaw swings
% Price Change ≈ −Duration × Change in Rates (percentage points)
Duration is a bond's sensitivity to rates, in years. Longer maturities and lower coupons mean higher duration. Every bond ETF lists its duration on its fund page. If rates rise 1 point:
| Example fund | Duration | −D × Δrates |
|---|---|---|
| Short-term Treasury ETF | 2 | −2% |
| Broad bond-market ETF | 6 | −6% |
| Long-term Treasury ETF | 16 | −16% |
A 2-point rise hits that long fund with −2 × 16 ≈ −32%, the opening question answered. Rates move stocks too: higher rates shrink the present value of distant earnings (Week 2), so high-P/E growth stocks are often hit hardest. Bond ETFs still earn a place as ballast because their correlation with stocks is usually low (Week 7). In the arena they trade like stocks, in whole shares at live prices.
Quick self-check
(a) A fund with duration 8 faces a 0.5-point rate fall. Price change? (b) A $40 coupon bond trades at $800. Current yield? (Answers: −8 × (−0.5) = +4%; 40 ÷ 800 = 5%.)
Common mistakes
- "Bonds can't lose money." Long-duration funds can drop by double digits.
- Chasing the highest yield. A fat yield pays you for extra risk.
- Dropping the minus sign. Rates up means prices down.
This week in the arena
Quote one bond ETF in Extrapoli and look up its duration and yield on its fund page. Estimate its price change if rates rose 1 point. Then compute its weight in your portfolio (Value ÷ Total value, zero if you don't hold it) and work out what that move would do to your whole portfolio.