Bond Price Volatility and Term to Maturity: A Generalized Respecification

Abstract

The apparent inability of analysts to explain the unusual bond price pattern reflects an incomplete understanding of the mathematics of bond prices. While price volatility is related to the time structure of a bond, it is not mathematically related to term to maturity in any simple way. However, the high market rates of interest in recent years have given greater practical importance to the inverse relationship between term to maturity and change in bond price. Duration is a concept first introduced by Frederick Macaulay to provide more complete summary information about the time structure of a bond than term to maturity. The inverse relationship between duration and coupon makes a higher coupon bond a shorter term bond than a lower coupon bond of the same maturity. The longer the term to maturity, the higher the coupon rate, or the higher the market yield, the more important are the coupon payments relative to the maturity payment.

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