Vernon Morning Star, 26 Jul 2009, Dave Ellis
Government bonds are always very liquid. So let’s focus on why it is possible that informed investors are wary of government bonds. Today, a 10-year government of Canada bond yields 3.29 per cent. It trades every day, and trades for $100 and comes due for $100. When a bond fund buys that bond for their portfolio, they will earn 3.29 per cent in interest by year end. But if interest rates were to increase by one per cent, so that investor demand was in the 4.29 per cent range, the price of that bond would decline to $92. It would trade for $92, so that a buyer at that level would get 4.29 per cent to maturity. So a one per cent increase in yield will cause an eight per cent drop in price. The volatility of that relationship, something bond traders refer to as duration risk, increases as the term to maturity increases. A one per cent increase in yields on a 20-year bond drops the price to $87.50, or a decline of 12.5 per cent.
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