Question

Suppose that you inherited some 2.25% US Treasury bonds from your grandfather that mature in 2027. Although they were originally purchased at par (and will mature at $1,000), they currently have a market value of around $950 each. If you believe that interest rates will continue to rise, should you sell, hold, or try to buy more? Explain why.

Answer 1

The treasury bonds bought at $1000 are currently at $950 and have a coupon rate of 2.25%.

So the current yield is: 2.96% Formula is: RATE(16,2.25%*1000/2,-950,1000,,)*2

If next year, the interest rate changes to 3.50%, then price becomes: $922.99. formula is PV(3.5%/2,14,2.25%*1000/2,1000,)

So the price reduces as the interest rate changes. If we hold the bond till maturity, then yield on bond is 2.25% while the current interest rates is more. Hence it makes sense to hold the bond till maturity. This is important as selling the bond and rebuying the bond will only add to transaction cost and the overall yield may be lesser due to the impact of the transaction costs.