Short-Term Bonds
Short-term bonds are those maturing within a year. They have low interest rate risk and high liquidity. Since long-term bonds last over a decade, if interest rates rise while you are holding them, bond prices will drop more than their yield; but short-term bonds have shorter maturities and thus lower sensitivity to changes in market interest rates. Treasury bills with 3-month and often 6-month maturities are referred to as short-term bonds. These are funds whose yields usually mirror current short-term market interest rates, which are mostly lower compared to those of medium and long-term bonds.
Short-term bonds pay less, but they are perfect for investors who need money in the near future. The returns are mainly derived from interest payments, and consequently, market price volatility is low. In the U.S., 3-month Treasury yields could fall anywhere between 1.5% and 2%, while one-year Treasuries might yield approximately from about 2% to 2.5%, depending on Fed policy (whether they lowered or hiked rates) as well as other economic conditions at that time.
Medium-Term Bonds
Medium and intermediate-term bond maturities range from 1 to around 10 years. Medium-term bonds pay more interest than short-term ones but are vulnerable to a higher rise in interest rates. A 10-year corporate bond might pay between 3% and 4%, but you would still receive more in annual yields during that period than short-term bonds. Compared to the two-year Treasury yield, this higher pace of return gives investors a buffer against overextended interest rate risk, protecting their longer maturities.
Longer-term medium bonds may pay a bit more interest for the extra duration risk. They exhibit more interest rate sensitivity, particularly when rates increase. The measure of interest rate risk can indicate how much a bond might fall with a 1% increase in rates or rise with a 1% decrease.
Long-Term Bonds
Long-term bonds are those maturing ten years and beyond. These bonds tend to have higher yields in return for the longer-term interest rate risk. A good example is a 30-year U.S. Treasury bond, which typically yields between 4% and 5% annually; however, the price of this bond can swing wildly as interest rates change. The duration of a long-term bond is over 20 years, so its price can easily change by more than 20% in response to just a 1% move in interest rates.
Long-duration bonds are designed for investors who can tolerate long-term investment risk. With large interest rate risk, investors must be very good at predicting future economic and interest rate trends. Long-term bonds are also more volatile, which means they tend to lose value when interest rates go up and gain value when rates fall, so investors often mix long-term bonds with equities as a way of reducing the overall risk in their investment portfolios.
Perpetual Bonds
Unlike fixed-maturity bonds, perpetual bonds have no specific date of redemption, and investors can hold them indefinitely. While these bonds tend to provide over-benchmark yields, they are also subject to higher credit risk based on the underlying issuer. Perpetual bonds, by definition, have no maturity date, so the duration is infinite—most or all of every dollar promised to bondholders will need to be paid back, making their price extremely rate-sensitive. This could mean that a perpetual bond essentially pays 5% to 6% per year, but its market price may vary considerably over time due to the volatility of interest rates.
Those looking to invest in something that will provide them with consistent cash flow over the long run. What you need to know: There is limited liquidity of these bonds, and since interest rates are expected to spike in the near future, an increase would considerably lower their prices. It is necessary to pay attention from the point of view of investors, by observing with greater intensity both the credit rating that corresponds to each issuer and determining whether its investments will get back on time in accordance with expectations.
Zero-Coupon Bonds
Zero-coupon bonds are sold at a discount and redeemed at face value at maturity, without paying interest between. The return results from the spread between the issuance price and the face value at maturity. Zero-coupon bonds are quite sensitive to interest rate changes because they do not pay periodic interest. A zero-coupon bond could, for instance, be issued at $700 and mature at its face value of $1,000 over time, resulting in a 42.86% return on investment.
The prices of zero-coupon bonds are subject to greater price volatility compared to coupon bonds, especially when interest rates shift. In a rising interest rate market, the price of zero-coupon bonds can fall heavily. These bonds are aimed at those who can bear higher price fluctuations and expect better returns in the future. Long-term investors will need clear expectations of what they can earn from zero-coupon bonds given their lack of periodic interest.
