Why is High Yield Corporate Fund less sensitive to interest?

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vuduthmb
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Why is High Yield Corporate Fund less sensitive to interest?

Post by vuduthmb »

I am in Vanguard's High Yield Corporate Fund (VWEAX.) I have read in a couple of places that this fund is less sensitive to changes in interest rates than other bonds. I realize that it is partly because of it being corporate bonds instead of treasury bonds, but I think that is not the whole story.
So why is this bond fund less sensitive to changes in interest rates?
Thank you.
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greenspam
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Re: Why is High Yield Corporate Fund less sensitive to inter

Post by greenspam »

from: http://www.investmentu.com/research/hig ... onds2.html

Price Determinates for High Yield Bonds

Since high yield bonds do not offer the same level of protection – compared to U.S. government and, to a lesser degree, investment-grade corporate bonds – company fundamentals (i.e. financial health and operating performance) along with general economic trends matter more than interest rates. That’s because these fundamentals determine whether the issuer has the cash flow wherewithal to keep up with debt obligations.

Although all bonds to one degree or another are affected by the level of interest rates (a bond’s price generally moves inversely to interest rates), company creditworthiness is of much greater importance with these types of bonds.

One important reason why high yield bonds are less sensitive to a rising interest-rate environment is the sizeable interest payments that overshadow a change in rates and the ability of HYB investors to reinvest these fat payouts at the new higher rates. In comparison, the top concern for Treasury investors is the level of interest rates and inflation. Investment-grade corporate bonds fall somewhere in between.
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Valuethinker
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Re: Why is High Yield Corporate Fund less sensitive to inter

Post by Valuethinker »

Higher coupon meanß lower sensitivity to changes in interst rates
exeunt
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Re: Why is High Yield Corporate Fund less sensitive to inter

Post by exeunt »

Also some of the interest rate sensitivity is masked by changes in credit spreads. When the economy is booming, credit spreads compress (leading to capital gains) while interest rates rise (leading to capital losses). The opposite occurs when the economy is tanking.
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magician
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Re: Why is High Yield Corporate Fund less sensitive to inter

Post by magician »

Price sensitivity to interest rate changes is measured by (modified or effective) duration: the longer the duration, the greater the price sensitivity.

For bonds without embedded options, the factors that affect duration are:

Time to Maturity: The longer the time to maturity, the longer the duration

Coupon: The lower the coupon, the longer the duration

Yield to Maturity: The lower the yield to maturity, the longer the duration

Amortization: Non-amortizing bonds have longer durations than amortizing bonds

(The original idea of duration - Macaulay duration - is a weighted-average time-to-receipt-of-money, where the amount of time until each payment is weighted by the fraction of the present value represented by that payment. Macaulay duration is easy to understand, and understanding it makes it easy to see why all of the factors listed above affect the duration as they do. A longer-maturity bond will obviously have a longer time to wait until the money is received; thus, longer duration. A low-coupon bond will get only a small portion of its value returned early, and the bulk of it returned late; thus, longer duration. When the YTM is low, it doesn't discount the (distant) future payments as much as when the YTM is high, so the present value of those distant payments is higher; thus, longer duration. A non-amortizing bond has 100% of the principle payment received at maturity, as opposed to an amortizing bond in which much of the principle is received earlier; thus, the non-amortizing bond has longer duration.)

Thus, a corporate bond with a higher coupon than a Treasury of similar maturity will have a lower duration than that Treasury, hence, lower interest-rate price sensitivity.
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