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Log on to www.investopedia.com to find a simple calculator for working out bond prices. (Start by clicking the Investing link.) Check whether a change in yield has a greater effect on the price of a long-term or a short-term bond.

Solution

Change in yield has greater impact in price of the long-term bond than on short-term bond.

The largest cash flow i.e. Bond’s face value is situated in the end of the period or maturity date. The cash flow falling in far future will get more discounting period or years hence the longest the time to get face value will impact make the bond more sensitive to yield.

In case of short term bond, the maturity date is close or short hence discounting rates don’t have that much impact as they have in case of long-term bonds.

Example:

There are two bonds below one short-term and other is long term, initially we worked on 5% yield for both bond and then changed yield to 6% to understand the sensitivity.

The change in price of the short-term bond is only 2.57% where as change in long term bond is 6.61%.

This proves that long-term bonds are more sensitive in nature.

Particular

Short term

Long term

Face value

1000

1000

Maturity in years

3

10

Yield

5%

5%

Coupon

100

100

Price

$1,136.16

$1,386.09

Particular

Short term

Long term

Face value

1000

1000

Maturity in years

3

10

Yield

6%

6%

Coupon

100

100

Price

$1,106.92

$1,294.40

Change in value

$29.24

$91.68

Change in %

2.57%

6.61%

Particular	Short term	Long term
Face value	1000	1000
Maturity in years	3	10
Yield	5%	5%
Coupon	100	100
Price	$1,136.16	$1,386.09