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@Freak: Maturity is pretty straightforward. A bond's maturity is the length of time until the principal must be paid back. So a 10-year bond will earn interest for 10 years from the date it is purchased. At the end of that time period the bond's principal is repaid to the owner of the bond and interest payments cease.
A bond's duration, on the other hand, is a more abstract concept often used to measure interest-rate sensitivity. Bond investors often pay attention to interest-rate movements because any movement up or down in rates has the opposite effect for bond prices. That's because an increase in interest rates makes an existing bond (and its now below-market interest rate) worth less while a drop in rates increases the bond's value. Regards, Ted Source M*
Interesting question(s) which caused me to review my own portfolio to see how it bubbles and how it has performed with respect to duration and maturity.
I am not sure this will help but I will share my findings. In review of my portfolio through Morningstar's Portfolio Manager a tabulation of all my funds reflect a duration of 3.3 years with an average maturity of 5.5 years while my proxy, a bond index fund, list a duration of 5.4 years with an average maturity of 7.5 years.
Even though, I hold a good bit in short duration and limited term funds when mixed with others raises my averages because many of my hybrid funds hold, for the most part, longer maturity bonds with higher duration readings. My shortest duration fund is GIFAX with a duration of 0.30 years with an average maturity of 4.66 years while one of my higher reading funds FBLAX has a duration reading of 5.76 years with an average maturity reading of 7.65 years.
However, from July through November, of this year, my income area reflects a gain in value. I believe this is due, in part, to many of my hybrid funds in this area holding some equities which have appreciated in value and thus far more than offset the decline in value of bonds held.
It will be interesting to see if this continues through anticipated forthcoming Fed rate increases.
Honestly, I've never thought about the impact of (or on) maturity for bonds of similar credit ratings. Generally when comparing two bonds or portfolios of equal duration (and quality), what matters is convexity.
That's a measure of how fast the duration (not the price) changes as interest rates rise. For the mathematically inclined, that makes it the second derivative of price with respect to rates (duration being the first derivative).
Look at a price vs. rates curve, e.g.
As rates rise, you move to the right and prices fall. You want that curve to flatten quickly, so that prices don't fall too far too fast. That means you want the slope (duration) to change rapidly from steeply falling to barely falling. This means you want a high convexity (rapid change in duration).
While bond listings often include convexity, fund listings unfortunately do not.
What you're looking for, I think, is something relating maturity to interest rate sensitivity (given same duration and credit quality). An interesting question, but after a few minutes thought, I don't think there's a simple relationship.
For example, given two portfolios (or bonds) with same duration, the one with the higher coupon bonds will have the longer maturity. (In the extreme, zero coupon bonds' maturity matches their duration, while interest bearing bonds' maturity is longer than their duration.) One can relate coupon to convexity, but that's usually done by assuming constant maturity, while the point here is that because the coupons are different the maturities are different, not constant (the same).
In that five minutes of thought I came up with at least three different possible impacts that longer maturities could have (based on the relationship to coupons, based on credit risk, based on principal repayment at maturity). Just gut feelings, and not all in the same direction. It gets even worse when one gets past vanilla bonds (call/put options, mortgage bonds with prepayments, stripped bonds, floating bonds with long maturities but "artificially" short durations, etc.)
A really interesting question, but one for which I don't have a good answer, so far.
A completely updated edition of the guide to modern bond analysis First published in 1972, Inside the Yield Book revolutionized the fixed-income industry and forever altered the way investors looked at bonds. Over forty years later, it remains a standard primer and reference among market professionals. Generations of practitioners, investors, and students have relied on its lucid explanations, and readers needing to delve more deeply have found its explication of key mathematical relationships to be unmatched in clarity and ease of application.
This edition updates the widely respected classic with new material from Martin L. Leibowitz. Along the way, it skillfully explains and makes sense of essential mathematical relationships that are basic to an understanding of bonds, annuities, and loans—in fact, any securities or investments that involve compound interest and the determination of present value for future cash flows. https://www.amazon.com/Inside-Yield-Book-Classic-Analysis/dp/111839013X
P S In lieu of that ,I think l"ll rely on our bond guys,namely Andy J and the Junkster.
So guys, I can read definition of Duration and definition of Maturity and understand it. What I am trying to figure out is I want to take some money from MM fund and invest in a Short/Ultrashort mutual fund, which have same duration, but differing maturity, everything else remaining the same which to I pick?
I'm thinking if the duration stays what it should, maturity may not matter since it simply means bonds are coming due and manager will purchase new bonds with same duration which some "maturity" left in them. On the other hand, if manager does not replenish the matured bonds then funds will be invested in cash, i.e. more conservative.
Several years ago, Michael Kitces put together a post on his blog site dealing with different measures of duration (duration, ave. duration, weighted ave. duration, etc.) and what each statistic would do for you and what it wouldn't. I marked it, but it is on another computer's HD that I have put to bed. You should be able to find it by searching his blog site's archive.
Why not buy some of both (entry positions) and add to them over time? If they both perform about the same (total return) all's well. If one out performs the other by big enough margin (thus you have discovered your answer) ... and, then can the other moving the assets to the better performer.
I have no idea which one your should buy because I don't believe both of them to be equal even though they have the same duration but different maturities. I suspect the short term fund has a higher yield over the money market fund; but, both might offer about the same total return.
I just don't know ... Therefore, why not buy some of each? And, then keep the better performer and, in time, can the other.
Consider: two bonds with same credit rating, same maturity (those two factors should produce same yield to maturity), same duration, non-callable vanilla bonds.
If one of those has less interest rate risk than the other, then maturity isn't going to help you decide which portfolio is safer. Your underlying assumption that same duration and same maturity means same risk would be wrong. You could slightly increase the duration and maturity of the safer bond and it would still be safer.
As I've already explained, all else being equal, the safer bond is the one with the greater convexity (flatter price/yield curve).
My two hypothetical bonds have 10 year maturity and 5% YTM. One has an annual coupon of 4.7%; the other has semi-annual coupons with an annual rate of 5% (2.5% per coupon). They both have modified durations of 7.79 years.
But the latter's convexity is greater (less interest rate risk). It is 77.43, while the former's convexity is 75.93.
To summarize - two bonds identical according to each measure you mentioned - duration and risk - plus one you didn't mention, credit quality (as reflected in YTM for the same maturity), yet with different interest rate risks.
Relative risk is ambiguous. I haven't even gotten into callable bonds (e.g. mortgage bonds).
All guess work I know, but might it be better to stay in a money market account or a CD ladder during rising rates? Part of me thinks buying short term bonds just means you are willing to lose less that if in long term bonds. Both will lose. At least cash in MM or CD form will make a little and increase return over time.
By going into MMAs (which are still doing much better than MMFs), one is betting on rates rising at at least a certain speed. If you lose that bet (rates don't rise as fast as expected), then short-intermediate funds could be the winners.
ISTM that CDs are the closest to a "neutral" wager. That interest rates will go up, but not so fast that liquid (MMA) rates will surpass them before they mature, but not so slowly that higher yielding bonds will come out ahead.
Comments
A bond's duration, on the other hand, is a more abstract concept often used to measure interest-rate sensitivity. Bond investors often pay attention to interest-rate movements because any movement up or down in rates has the opposite effect for bond prices. That's because an increase in interest rates makes an existing bond (and its now below-market interest rate) worth less while a drop in rates increases the bond's value.
Regards,
Ted
Source M*
Interesting question(s) which caused me to review my own portfolio to see how it bubbles and how it has performed with respect to duration and maturity.
I am not sure this will help but I will share my findings. In review of my portfolio through Morningstar's Portfolio Manager a tabulation of all my funds reflect a duration of 3.3 years with an average maturity of 5.5 years while my proxy, a bond index fund, list a duration of 5.4 years with an average maturity of 7.5 years.
Even though, I hold a good bit in short duration and limited term funds when mixed with others raises my averages because many of my hybrid funds hold, for the most part, longer maturity bonds with higher duration readings. My shortest duration fund is GIFAX with a duration of 0.30 years with an average maturity of 4.66 years while one of my higher reading funds FBLAX has a duration reading of 5.76 years with an average maturity reading of 7.65 years.
However, from July through November, of this year, my income area reflects a gain in value. I believe this is due, in part, to many of my hybrid funds in this area holding some equities which have appreciated in value and thus far more than offset the decline in value of bonds held.
It will be interesting to see if this continues through anticipated forthcoming Fed rate increases.
Cordially,
Skeet
That's a measure of how fast the duration (not the price) changes as interest rates rise. For the mathematically inclined, that makes it the second derivative of price with respect to rates (duration being the first derivative).
Look at a price vs. rates curve, e.g.
As rates rise, you move to the right and prices fall. You want that curve to flatten quickly, so that prices don't fall too far too fast. That means you want the slope (duration) to change rapidly from steeply falling to barely falling. This means you want a high convexity (rapid change in duration).
While bond listings often include convexity, fund listings unfortunately do not.
What you're looking for, I think, is something relating maturity to interest rate sensitivity (given same duration and credit quality). An interesting question, but after a few minutes thought, I don't think there's a simple relationship.
For example, given two portfolios (or bonds) with same duration, the one with the higher coupon bonds will have the longer maturity. (In the extreme, zero coupon bonds' maturity matches their duration, while interest bearing bonds' maturity is longer than their duration.) One can relate coupon to convexity, but that's usually done by assuming constant maturity, while the point here is that because the coupons are different the maturities are different, not constant (the same).
In that five minutes of thought I came up with at least three different possible impacts that longer maturities could have (based on the relationship to coupons, based on credit risk, based on principal repayment at maturity). Just gut feelings, and not all in the same direction. It gets even worse when one gets past vanilla bonds (call/put options, mortgage bonds with prepayments, stripped bonds, floating bonds with long maturities but "artificially" short durations, etc.)
A really interesting question, but one for which I don't have a good answer, so far.
Jeffery Gundlach recommended/referenced this for Bond Investors in his latest webcast.
Inside the Yield Book: The Classic That Created the Science of Bond Analysis, 3rd Edition
Martin L. Leibowitz, Sidney Homer, Stanley Kogelman with Anthony Bova
http://www.wiley.com/WileyCDA/WileyTitle/productCd-111839013X.html
A completely updated edition of the guide to modern bond analysis
First published in 1972, Inside the Yield Book revolutionized the fixed-income industry and forever altered the way investors looked at bonds. Over forty years later, it remains a standard primer and reference among market professionals. Generations of practitioners, investors, and students have relied on its lucid explanations, and readers needing to delve more deeply have found its explication of key mathematical relationships to be unmatched in clarity and ease of application.
This edition updates the widely respected classic with new material from Martin L. Leibowitz. Along the way, it skillfully explains and makes sense of essential mathematical relationships that are basic to an understanding of bonds, annuities, and loans—in fact, any securities or investments that involve compound interest and the determination of present value for future cash flows.
https://www.amazon.com/Inside-Yield-Book-Classic-Analysis/dp/111839013X
P S In lieu of that ,I think l"ll rely on our bond guys,namely Andy J and the Junkster.
I'm thinking if the duration stays what it should, maturity may not matter since it simply means bonds are coming due and manager will purchase new bonds with same duration which some "maturity" left in them. On the other hand, if manager does not replenish the matured bonds then funds will be invested in cash, i.e. more conservative.
So should I pick the fund with lower maturity?
Why not buy some of both (entry positions) and add to them over time? If they both perform about the same (total return) all's well. If one out performs the other by big enough margin (thus you have discovered your answer) ... and, then can the other moving the assets to the better performer.
I have no idea which one your should buy because I don't believe both of them to be equal even though they have the same duration but different maturities. I suspect the short term fund has a higher yield over the money market fund; but, both might offer about the same total return.
I just don't know ... Therefore, why not buy some of each? And, then keep the better performer and, in time, can the other.
Skeet
Consider: two bonds with same credit rating, same maturity (those two factors should produce same yield to maturity), same duration, non-callable vanilla bonds.
If one of those has less interest rate risk than the other, then maturity isn't going to help you decide which portfolio is safer. Your underlying assumption that same duration and same maturity means same risk would be wrong. You could slightly increase the duration and maturity of the safer bond and it would still be safer.
As I've already explained, all else being equal, the safer bond is the one with the greater convexity (flatter price/yield curve).
My two hypothetical bonds have 10 year maturity and 5% YTM. One has an annual coupon of 4.7%; the other has semi-annual coupons with an annual rate of 5% (2.5% per coupon). They both have modified durations of 7.79 years.
But the latter's convexity is greater (less interest rate risk). It is 77.43, while the former's convexity is 75.93.
To summarize - two bonds identical according to each measure you mentioned - duration and risk - plus one you didn't mention, credit quality (as reflected in YTM for the same maturity), yet with different interest rate risks.
Relative risk is ambiguous. I haven't even gotten into callable bonds (e.g. mortgage bonds).
Here's the Excel sheet I used to calculate this (search for download):
http://www.spreadsheetml.com/finance/bondduration_convexity.shtml
ISTM that CDs are the closest to a "neutral" wager. That interest rates will go up, but not so fast that liquid (MMA) rates will surpass them before they mature, but not so slowly that higher yielding bonds will come out ahead.
Place your bets and spin the wheel.