10-Year Bond Vs. 20-Year Bond

The Time Factor

Time impacts every aspect of the financial world and plays a significant role in determining the return that an investor requires from any security. There are three components to a bond: the face value, the coupon payment or interest rate and the price the investor actually pays for the bond. While the first and second never change, all three are still greatly affected by the length of time that the investor's capital is tied up because of the impact of inflation and the risk of market volatility.

Interest rates between a 10-year and 20-year bond differ tremendously. Reviewing the data for Treasury bonds reveals between a 1- and 3-percent jump from a 10-year bond to a 20-year bond on almost any given date. The reason is two-pronged. First, the risk that market interest rates will significantly fluctuate grows as the time line increases. Second, inflation causes the value of a dollar to decline on a regular basis. The average is 3 percent per year. This means than an investor tying up $1,000 for 20 years is losing much more of his purchasing power, or ability to buy goods, than one tying up that same sum of money for 10 years.

Increased risk and changes in interest rates causes a bond's price to deviate from its face value, selling at either a premium or discount. A $1,000 bond selling at a premium might sell for $1,120 in the market; at a discount, it might sell for $950. Bond duration allows an investor to measure a bond's price sensitivity to changes in market interest rates. Duration is actually the moment in time when there is no interest rate risk or reinvestment risk. The latter is the risk that the investor will not be able to reinvest a coupon payment at the same rate she earns with the bond. The longer the length of time until maturity, the longer a bond's duration. This means there is a higher risk associated with a 20-year bond.

When an investor faces a greater risk, he should seek higher returns as a reward. The yield, or return, on a bond is a component of the coupon payments and the face value. The investor receives the coupon payments for a 20-year bond for 10 years longer than a 10-year bond, even if both carry the same face value. However, those coupon payments are slightly eroded by inflation over time. There is relatively little difference in yield between a 10- and 20-year bond selling at the same price, with the same face value and coupon payments. However, that will rarely occur in the market place, given the risk over an investor tying up capital for that length of time.