effects of interest rate increase. duration and yield on bon

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effects of interest rate increase. duration and yield on bon

Postby Islander » Sat Jan 26, 2013 9:58 am

If interest rates increase say by i%, I assume that refers only to treasuries having a specific maturity and duration.
If that's correct does yield combine with duration to impact a bond fund's NAV?

Specifically, assume two treasury bond funds in different time periods. Both have same duration but one yields 4% and the other 1.5% and interest rates for
that bond duration rise 1%. Would the reduction in NAV for the higher yielding fund be less because of the higher yield? This question evolved from my
understanding that rising interest rates have less of an effect on corporate and high yield bond funds due to their higher yields.
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Re: /effects of interest rate increase. duration and yield o

Postby nisiprius » Sat Jan 26, 2013 10:33 am

My understanding, perhaps faulty, is that "the" average duration of a bond fund accurately expresses the effect of a small, instantaneous change in interest rates on the NAV of the fund, and thus the flavor of bond in the fund, yield, etc. wouldn't matter. There's some (literally) second-order effect called "convexity," meaning that for larger changes in interest rates, the effect isn't proportional--a 5% interest rate rise does less than five times the damage of a 1% rise, and that the convexity varies for different bond flavors. Given the utter inability of anyone to predict interest rates at all, I personally don't "get" the point of fussing about convexity, other than to say that of course riskier bonds are going to be generally less predictable in all respects.

I also don't "get" the frequent statements that corporate bonds have higher yield than Treasuries, if they're talking about anything more than just plain compensation for the extra credit risk. Seriously, during the time period shown would it have mattered much to anyone whether they were in the Vanguard Intermediate-Term Treasury fund, or the Vanguard Intemediate Term Investment Grade [Corporate bond] fund--unless they'd had a pressing needed to liquidate right during 2008-2009? Doing a rough calculation, (33,366.55/31,443.35)^(1/20.2) = 0.3%, i.e. Vanguard Intermediate-Term Investment Grade earned 0.3% more than Vanguard Intermediate-Term Treasury, and you certainly paid for that with some excitement around 2008-2009.

Image

Also, note the difference during the bond bubble of 1993 and the bond massacre of 1994. Difference, as in, what difference? (Nope, not a whole lot if you move the endpoints to bracket those years. Try it.

Look, I know growth charts are a blunt instrument. Yes, those nasty old dividends those pesky bond funds keep paying make it harder to see the fluctuations in NAV. But I'd at least use them to put the qualitative statements made by connoisseurs into perspective. If this did that, these would do one thing and those would do the other--but you don't know whether this will do that. If we had ham, could have ham and eggs, if we had some eggs.

I sure hope people aren't getting fooled by three-year return numbers, which still put the starting point inside that nasty little notch.
Last edited by nisiprius on Sat Jan 26, 2013 10:47 am, edited 2 times in total.
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Re: /effects of interest rate increase. duration and yield o

Postby midareff » Sat Jan 26, 2013 10:43 am

Your point is very well presented Nisi .. however..... .3% on $250,000 is still $7,500 a year in interest regardless of the decline or reverse bubble taken by investment grade during the market hit. A retiree supplementing their income with the interest proceeds might think there is a difference of some significance.

If you deduct the $10K starting investment and look at the 20.2 year returns you have $23,366.55 vs. $21,443.35, or a return difference of 8.97%. Looking at the return portion of the investment the return on IG was 5.4% larger. If the investment is $10K it might not be much, if the investment is larger the results can look significantly different.

Had you used that nasty little notch as a buying opportunity your return todate on that $10K investment would have been $6,207.56 vs. $2,896.89 .. (M*'s numbers, not mine). ... hindsight is such a wonderful thing. :oops:
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Re: /effects of interest rate increase. duration and yield o

Postby Matigas » Sat Jan 26, 2013 11:13 am

midareff wrote:Your point is very well presented Nisi .. however..... .3% on $250,000 is still $7,500 a year in interest regardless of the decline or reverse bubble taken by investment grade during the market hit. A retiree supplementing their income with the interest proceeds might think there is a difference of some significance.

If you deduct the $10K starting investment and look at the 20.2 year returns you have $23,366.55 vs. $21,443.35, or a return difference of 8.97%. Looking at the return portion of the investment the return on IG was 5.4% larger. If the investment is $10K it might not be much, if the investment is larger the results can look significantly different.

Had you used that nasty little notch as a buying opportunity your return todate on that $10K investment would have been $6,207.56 vs. $2,896.89 .. (M*'s numbers, not mine). ... hindsight is such a wonderful thing. :oops:



Huh?
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Re: /effects of interest rate increase. duration and yield o

Postby midareff » Sat Jan 26, 2013 11:51 am

Nisi's data in the M* chart is based on a $10K investment. If you take the return amounts less the investment amount a different set of return percentages are present. While the return differences on a $10K investment over 20 years is not large it is very different on a $250K investment.

Got it now?
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Re: /effects of interest rate increase. duration and yield o

Postby Islander » Sat Jan 26, 2013 12:37 pm

Am still struggling with this.

Since the difference in nominal rates of treasuries and corporates of the same maturity is greater than 0.3%, is not the M* chart and its results
simply an abberation due to the 20+ year bull market in treasuries exacerbated by the more recent flight to the safety of treasuries. Looking forward with
the end of the treasury bull market in sight, if not here, I would expect to see a much different chart.
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Re: /effects of interest rate increase. duration and yield o

Postby midareff » Sat Jan 26, 2013 12:56 pm

Islander wrote:Am still struggling with this.

Since the difference in nominal rates of treasuries and corporates of the same maturity is greater than 0.3%, is not the M* chart and its results
simply an abberation due to the 20+ year bull market in treasuries exacerbated by the more recent flight to the safety of treasuries. Looking forward with
the end of the treasury bull market in sight, if not here, I would expect to see a much different chart.


My belief is that you are absolutely correct although the interest rate induced bond market can not be discounted for corporates either. Since treasuries have such a low SEC/yield compared to corporates their recovery rate to duration induced price declines has to be significanly longer than corporates of similar duration. VG IT Treasuries .72 SEC and 5.3 duration, VG IT Corporates 2.07 SEC and same 5.3 duration. This also implies they did benefit to a greater extent in the interest rate decline.
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Re: /effects of interest rate increase. duration and yield o

Postby Matigas » Sat Jan 26, 2013 4:48 pm

midareff wrote:Nisi's data in the M* chart is based on a $10K investment. If you take the return amounts less the investment amount a different set of return percentages are present. While the return differences on a $10K investment over 20 years is not large it is very different on a $250K investment.

Got it now?

The part I do not get is how you figure .3% on $250,000.00=$7,500.00 a year in interest.
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Re: /effects of interest rate increase. duration and yield o

Postby midareff » Sat Jan 26, 2013 5:36 pm

FAT fingers on a small calculator.. :oops: I stand corrected and thank you for pointing that out. :sharebeer It is $750 a year, not $7,500. That said, over Nisi's 20.2 year period it would be $15,150 ... for which I believe one could buy their grandchild a new Fiat 500 for a HS graduation present or take the Mrs. on quite a vacation or international tour.

FWIW, many drops fill a bucket eventually. $750 here, $1200 or more in credit card cash rebates and give backs, couple of hundred on Ally MM and checking interest, and on and on... the point being, these things do make a difference.
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Re: effects of interest rate increase. duration and yield on

Postby Islander » Sun Jan 27, 2013 7:33 am

Midareff,

Do not understand the following; "... although the interest rate induced bond market cannot be discounted for corporates either" Please explain.
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