Can someone summarize the different situations in which it is better to have a bond with a longer maturity, or a higher/lower coupon based on the type of risk you are trying to avoid? example: Interest rate risk is higher for bonds with higher maturities vs. lower maturities. what are the other situations and rules?
Regarding reinvestment risk, longer bond, lower yield and *higher* coupon is worse. Regarding interest rate risk, longer bond, lower yield and *lower* coupon rate is worse.
Thanks, Whats the logic behind longer bond and lower yield being worse for reinvestment risk. And what’s the logic behind the lower yield being worse for intererst rate risk?
Victor – I’m not sure about your statement on yield and reinvestment risk. The maturiy and coupon statement are correct. Longer maturity and higher coupon means more of your total cash flow needs to be reinvested, thereby exposing you to increased interest rate risk. At a lower yield, a 1bps move in the yield will cause a larger change in price than a 1bps move would at a higher yield. THis is due to the shape of the yield curve with is convex.
but all thing equal, lower yield = higher duration. higher duration = more risk, however i am not sure whether that risk is attributed to reinvestment, or interest rate risk.
This question is too broad. A subject such as FI and the different relationships can’t really be easily summarized, cuz it has too many variables and a lot of them are moving.
Remember the three L’s Longer maturity, Lower coupon and Lower yield -----> high interest rate risk.