In this context, we are concerned with the current market value (eg a $9bn bond) and how this holding may devalue due to Rising interest rate for that particular maturity.
* lower (zero) coupon bonds are more sensitive. More of the cash flow occurs in the distant future, therefore subject to more discounting.
* longer bonds are more sensitive. More of the cashflow is “pushed” to the distant future.
* lower yield bonds are more sensitive. On the Price/yield curve, at the left side, the curve is steeper.
(I read the above on a slide by Investment Analytics.)
Note if we hold the bond to maturity, then the dollar value received on maturity is completely deterministic i.e. known in advance. There are 3 issues with this strategy:
1) if in the interim my bond’s MV drops badly, then this asset offers poor liquidity. I won’t have the flexibility to get contingency cash out of this asset.
1b) Let’s ignore credit risk in the bond itself. If this is a huge position (like 2 trillion) in the portfolio of a big organization (even for a sovereign fund), a MV drop could threaten the organization’s balance sheet, credit rating and borrowing cost. Put yourself in the shoes of a creditor. Fundamentally, the market and the creditors need to be assured that this borrower could safely liquidity part of this bond asset to meet contingent obligations.
Fundamental risk to the creditors – the borrower i.e. the bond holder could become insolvent before bond maturity, when the bond price recovers.
2) over a long horizon like 30Y, that fixed dollar amount may suffer unexpected higher inflation. I feel this issue tends to affect any long-horizon investment.
3) if in the near future interest rises sharply (hurting my MV), that means there are better ways to invest my $9bn.