Identifier: C2T2L5 | Revision: 2026-10-26

Decision and objectives

A borrower promises the same credit quality on one-year and five-year debt. The longer issue offers a higher coupon. Before allocating a reserve, test how a rate shock affects the amount available at the reserve's withdrawal date. Longer maturity usually puts more present value into distant cash and increases rate sensitivity; the cash schedule, not the maturity label alone, is decisive.

Objectives: Reprice two maturities under a parallel shock; Calculate money and percentage losses; Compare cash matching with a yield choice.

Prerequisites: C2T2L4.

Mechanics

For a fixed noncallable bond, future coupons and principal do not change when the market yield changes. Today's sale value changes because investors can buy different yields elsewhere. The holder who waits may still receive nominal payments in full, but loses the ability to sell at the former price. The holder also faces reinvestment risk on early coupons and inflation risk in the spending currency.

Price and return drivers

Reprice each payment at the shocked curve rather than subtracting the yield change directly from the coupon. A parallel shift changes all curve points by the same number of percentage points. A steepening or flattening changes them differently. The single-yield examples here intentionally use flat curves to isolate maturity; C2T4 develops faster approximations and their limits.

Worked case

Hypothetical same-credit zero-coupon securities: both repay TRY 100,000, one in one year and one in five years. Flat annual effective yield is 10%; no fees, tax or default. One-year price = 100,000 / 1.10 = TRY 90,909.09. Five-year price = 100,000 / 1.10⁵ = TRY 62,092.13. A zero pays no interim income, so all value is tied to the final date.

Immediately after purchase, the whole flat curve rises to 12%. New one-year price = TRY 89,285.71; loss TRY 1,623.38, or 1.7857%. New five-year price = 100,000 / 1.12⁵ = TRY 56,742.69; loss TRY 5,349.45, or 8.6153%. These compare the same nominal amounts; allocating equal initial cash would require different face amounts. State which comparison is being made.

Adverse case

If yields instead fall to 8%, one-year price becomes TRY 92,592.59 and five-year price TRY 68,058.32. Gains are not exactly the negatives of the 12% shock losses because the price-yield relationship is curved. A buyer planning to sell after one year cannot rely on the five-year issue's final redemption to pay a near-term bill; it still has four years of rate exposure at that point. Conversely, a one-year bill repeatedly rolled over cannot lock five-year reinvestment rates.

Practical use

Obtain same-time executable quotes, denomination and settlement terms before making the model comparison operational. A nominally lower-volatility instrument can still be unsuitable when it trades only in a denomination larger than the reserve. Net sale amounts require the exit bid and costs, not a model mid. Tax and currency are held constant and excluded here; do not transfer the ranking to bonds in different currencies or tax regimes.

Decision boundaries

Choose the schedule that supports the liability date rather than the highest quoted yield. A long zero may match a fixed distant nominal payment more exactly than a coupon bond, yet be unsuitable for emergencies. A short bill reduces sale-price sensitivity but increases rollover exposure for a long objective. Neither choice eliminates default or inflation risk. Decline the long issue for money that must be available next month with no loss buffer.

Practice and references

Exercise: hypothetical three-year zero repays TRY 50,000. Annual effective yield moves immediately from 8% to 11%; no time passes or costs/tax. Answer: initial price = 50,000 / 1.08³ = TRY 39,691.61; shocked price = 50,000 / 1.11³ = TRY 36,559.57; loss = TRY 3,132.04, or 7.8909% of initial value.

Takeaway: maturity changes how much today's sale value depends on future discount rates.

Reference guide: domestic-government-bond, simplified-bond-price, Parallel curve shift, Interest rate risk.

Next: C2T3L1. Topic test: C2T2.

Primary sources (checked 2026-10-26; changing terms require a publication recheck): SEC Investor Bulletin: What Are Corporate Bonds? — Interest rate risk, credit risk, call risk and seniority.

Shared reference guide | Class examination