EC The No-Lose Line -

EC The No-Lose Line

Nov 19, 2014Jeremy ParkinsonEntertainment0

How long can you hold a Treasury Note or Bond, and not suffer a loss in total return terms, if yields rise from where they are today? Maybe the answer will surprise you, and maybe not — it depends on how fixed-income literate you are.

Okay, here’s the scenario: I start off with the current yield curve for 2-, 5-, 10-, and 30-year Treasuries (0.51%, 1.61%, 2.32% and 3.04%). I make the following assumptions:

Annual Coupon Payment at the end of the year (at the current bond equivalent yield)

The bonds are priced at par, so they are current coupon bonds.

They are new bonds with the full maturity to go.

Each year, the coupon payment is reinvested in bonds of the same type.

Each scenario is run until there is one year left to go. The rate in the last year is the total return earned in the scenario if the notes/bonds pay off.

I’m not considering inflation, so these will be real losses if inflation is positive on average.

Those that hold don’t need to earn any income, unlike insurers, banks, pension plans and endowments. We could do the same analysis for them, but the lines would look flatter, because they can’t afford to lose as much.

So, what higher yield rate on the bonds will make the total return zero as the years elapse? That’s what the above graph shows… so what can we learn from that?

For 5-,10- and 30-year Treasuries, a yield rate near 3.03% will hold the package to roughly a zero total return after 2 years. After 3 years, that same figure is around 3.74%.

As time elapses, scenarios above the lines would represent losses on a total return basis, and below the line would be gains. The path itself would matter a little, but the latest position more. The graph can be used in another way also… if you have an idea of how high you think interest rates will go, you will have a have an idea of how long it would take to break even. Remember, if the Treasury is “money good,” you get it all back at the maturity of the note/bond.