Yield vs Duration vs Price: Which Decides
When Treasury yield, price, or duration is the number that decides: holding to maturity, selling early, and comparing a 2-year with a 10-year.
By Prosperics Editorial Board · DIGITI LLC
Prosperics is published by DIGITI LLC, a California company. Calculators and guides are written and maintained by the Prosperics editorial board. Figures are checked against primary sources — IRS, CRA, SSA, and central bank publications — and each page shows the date it was last reviewed.
Yield, price and duration are three different bond facts
Prosperics' Bond Tracker (prosperics.com/bonds-tracker) plots US Treasury yields by maturity. Yield, price and duration each answer a different question, and using one in place of another is how a 2-year versus 10-year choice goes wrong.
Price is what you pay today for the remaining coupons and the principal. Yield to maturity is the single discount rate that makes the present value of those cash flows equal the price. When the price rises, the yield falls, and when the price falls, the yield rises. That inverse link is an identity for a given bond, not a forecast. The coupon rate is neither of these: it is the interest printed on the bond, and it does not change when the market price does.
Duration measures how much the price moves when yields move. Modified duration is approximately the percentage price change for a one percentage point change in yield. A bond with a modified duration of 8 falls about 8 percent in price if its yield rises by one percentage point, and rises about 8 percent if the yield falls by one point. Duration is not the maturity date. A coupon-paying 10-year Treasury has a duration well under 10 years, because some of its cash arrives as coupons before maturity. A 2-year Treasury has a duration a little under 2 years. The longer the duration, the larger the price swing for the same yield change.
The curve, Treasury versus corporate credit, and bond ladders are in the longer guide at prosperics.com/learn/bonds-yield-duration. This page is only about which of the three numbers decides.
Key takeaways
- ✓Price and yield to maturity move in opposite directions; the coupon rate does not change with the market
- ✓Modified duration estimates the percent price change for a one point move in yield
- ✓Duration is shorter than maturity for coupon bonds, and it is the scale of the price risk
When yield, price, or duration is the number that decides
Hold to a date you already know, and yield decides. If you buy a Treasury and keep it until it matures, you receive the remaining coupons and the face value regardless of what the price does in between. The yield to maturity at purchase is the return you locked in, aside from reinvesting the coupons. For money you will need in two years, the 2-year yield on the tracker is the relevant number. A higher 10-year yield does not help if you cannot stay for 10 years.
Sell before maturity, or you are looking at a portfolio you might have to sell, and price decides. A fall in yields raises the price of the bond you already own; a rise in yields cuts it. You only convert that move into cash by selling. Someone who bought a 10-year note and needs the money after a rate increase realizes a loss that holding to maturity would have avoided.
Compare two maturities, or any two bonds, for how a rate move would treat them, and duration decides. In a rate cut, the higher-duration bond gains more in price. A 10-year Treasury, with duration several times a 2-year's, moves more than the 2-year for the same change in yield. In a rate rise, that same extra duration is a larger loss if you sell. The label 10-year is not the comparison; the duration is.
The yields on the Prosperics tracker are the market's current Treasury yields by maturity, which is the right panel for what a new purchase locks in today. They are not the yield of a bond you bought earlier, and they are not a prediction of next month's price.
Key takeaways
- ✓Holding to maturity: yield to maturity is the return you locked in
- ✓Selling early: price is what you get, and a rate rise can lock in a loss you could have waited out
- ✓Comparing a 2-year with a 10-year for a rate move: duration, not the maturity label, sets the size
Yield traps that make the wrong bond look safer
A higher yield is not a better bond if you cannot live with the duration. The long end of the Treasury curve often yields more than the 2-year, and that extra yield is payment for more price movement. If the money has a date, taking the higher yield and then selling early can erase more than the extra income. Current yield, the coupon divided by the price, is also not yield to maturity. A bond trading above par has a current yield above its yield to maturity, and one trading below par has the reverse. Quoting the coupon rate as the return is a third, older version of the same mistake.
The par yields on a curve chart are the yields for new Treasuries, not the yield you are earning on a note already in an account. After you buy, your locked-in yield stays put while the chart moves. And this comparison is about interest-rate risk on Treasuries. A corporate bond's extra yield includes credit risk, call risk, or both. That decision, and how a ladder spreads reinvestment and price risk, is the subject of prosperics.com/learn/bonds-yield-duration, not of a single yield number.
Read the maturity you might actually hold on prosperics.com/bonds-tracker, decide whether you will hold or you might sell, and only then let yield, price, or duration be the figure you act on.
Key takeaways
- ✓Extra yield on a longer bond is pay for extra price risk, not free income
- ✓Coupon rate and current yield are not yield to maturity; the curve is not the yield on a bond you already own
- ✓Corporate spreads, calls and ladders are a separate decision, covered in the bonds guide
Sources
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