4.2 Maturity Pull
If the (way-) earlier bond were a zero-coupon bond (see page headed: “Fixed Income Securities: Dollar Price and Yield-to-Maturity”), at a discount rate of 10% – semi-annually for five years – (Case 1) it would be priced at $613.90 and at a discount rate of 12% (Case 2) it would be $558.40 per $1,000 of Face Value. The price would simply be the discounted value of the one-time maturity payment at the relevant YTM discount rate.
After one period, the bond would be priced at $644.60 and $591.90 respectively. Year after year the price would continue to rise until it reached par at its final maturity. This is what is meant by “maturity-pull.” In fact, the amount by which the dollar price changed would be equal to the accretion of $30.70 (in Case 1).
- Can you define “accretion”?
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- The amount by which a discount bond has increased in value due merely to the passage of time. As we will see soon, a premium bond will decrease in value over time. This assumes no change in YTM discount rate,
If the discount rate changes over the bond’s life, as is likely due to changes in market yield-to maturity, the market price path to par may not be smooth. Furthermore, it is even possible that, if yield goes up sufficiently over the course of a given year, the subsequent year’s price may be lower than the prior year’s. This would be a function of the extent to which the market yield rose, and the bond’s term-to-maturity at that point.
If you think this is unrealistic, suppose you purchase a 5-year zero coupon bond in order to capture the higher YTM that presents itself in a normal, positive yield curve environment, and suppose that your investment horizon were only one-year? In other words, you intend to see the bond after just one year.
