Article 13.1 Investors lap up ultra-long corporate bonds

By Vivianne Rodrigues

Financial Times June 11, 2014

Global sales of corporate bonds maturing in 50 years have jumped to record levels this year as investors are flocking to the securities, lured by the higher yields offered by the debt.

Total issuance of ultra-long corporate debt jumped to $56.5bn in 2013, a rise of 84% from 2012.

Strong demand has boosted total returns on the debt, with investors for now leav­ing aside concerns about duration exposure - a measure of the sensitivity of bond prices to changes in interest rates - in their bond portfolios.

Longer-dated bonds are more sensitive to duration risks.

In spite of rising expectations of higher US bond yields, which may hurt long-dated corporate debt, there has been no shortage of buyers for 50-year dollar bonds sold in 2014 by companies such as Caterpillar, South Carolina Electric & Gas, Volkswagen and EDF.

‘For people who are comfortable with some duration exposure, these bonds offer a good opportunity to capture 20 or sometimes even 30 basis points in additional yield,' said Adrian Miller, at GMP Securities.

‘For high-grade companies, this is a great chance to raise very long-term funding at low costs.'

On Tuesday, building-supply maker Johnson Controls sold $450m in 50-year bonds as part of a $1.7bn offering. Demand for the 50-year tranche surpassed the $3bn mark, according to people familiar with the sale. The 50-year bonds offered yields 30 basis points higher than those offered by the company's 30-year debt.

However, a turn higher in rates still stands to hurt those investors chasing the higher yields on longer-dated debt... the clock is ticking for long-term interest rates.

FT

Source: Rodrigues, V. (2014) Investors lap up ultra-long corporate bonds, Financial Times, 11 June.

Duration and changes in yield to maturity

The time to maturity of a bond is not enough on its own to tell you what its volatility level is.

Table 13.4 Calculating duration on a four-year 7% coupon bond when the yield to maturity is 10%

With the interest rate at 10%, duration has fallen from 3.6243 years to 3.603 years. This is because at the higher interest rate the more distant cash flows are discounted more heavily and thus comprise a lower overall proportion of the overall discounted cash flows - the nearer-term cash flows gain relative weight as the duration reduces.

This illustrates another rule:

If interest rates rise, the duration falls (keeping everything else constant).

Article 13.2 discusses how the difference in yield between investment-grade and junk bonds causes significantly greater interest rate risk for investment­grade securities.