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February 11, 2013 11:40 pm
Why in the world would anyone consider bonds that won’t be repaid for half a century? By then we could have time travel, robots running companies, perhaps no interest rates at all. The answer is that long-term debt is dirt cheap – right here, right now. Thirty-year Treasuries are currently yielding 3.20 per cent.
These historically low US interest rates have prompted calls for the Treasury to sell more long-term debt, perhaps even 50-year bonds. Long bonds that long are not new. The idea has come up before in the US. Both the UK and France have sold similarly long-dated paper, and a number of companies and universities have issued debt with maturities of 50 and even 100 years over the past two decades.
Most of the buyers lured by super-long maturities – pension funds and insurance companies – are looking to match super-long liabilities. But the bond maths shows that extending the maturity beyond 30 years does not produce that much more duration. That is because of the time value of money: the further into the future the cash flows are, the less they are worth today. For example, Coca-Cola issued century bonds in 1998 that have a current duration of 19 years, according to Bloomberg. That same year it issued debt due in 2038 that now has a duration of 14 years. Investors often buy repackaged versions of these bonds that strip out the near-term coupons in order to boost duration. Very long dated bonds have done well over the years. The price of Coke’s bonds due in 2038 is 135 cents on the dollar, while the 100-year ones are at 141. Both were first sold just below 100.
But all bonds have had the benefit of a 30-year bull market. When rates eventually rise, the price of bonds, particularly long-dated ones, must fall. Pension plans and insurers would benefit from falling values of their liabilities, too. But it would still be an ugly correction.
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