Tag: Austrian century bonds

Supports: Money, Banking, and the Financial System, Chapter 3, Section 3.5

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The 30-year U.S. Treasury bond has the longest maturity available on a bond issued by the U.S. government. Some other governments have issued century bonds, which are bonds that don’t mature for 100 years. Bonds with maturities longer than 30 years are sometimes called ultra-long-term bonds. For example, in June 2020 the government of Austria issued a bond that will mature in June 2120. The bond has a par value of €100 and a coupon rate of 0.85%, which seems low but was high in comparison with the yields on other European government bonds at the time. For example, the yield on the 10-year German government bond was negative from April 2019 through January 2021.

Today (April 25), in a newsletter from the Wall Street Journal, Spencer Jakab noted that: “With a little over 95 years remaining, those [Austrian century] bonds now fetch 35 cents on the euro. Investors aren’t worried about being repaid ….”

a. What does Jakab mean that the “bonds now fetch 35 cents on the euro”?

b. If the investors aren’t worried about the Austrian government making coupon or principal payments on the bond, why do the bonds fetch only 35 cents on the euro?

Solving the Problem
Step 1: Review the chapter material. This problem is about the relationship between the interest-rate risk on a bond and the bond’s maturity, so you may want to review Money, Banking, and the Financial System, Chapter 3, Section 3.5, “Interest Rates and Rates of Return.”

Step 2: Answer part a. by explaining what Jakab means by writing that Austrian century bonds that mature in 2120 now fetch “35 cents on the euro.” The bonds have a par value (or face value) of €100. By “35 cents on the euro,” Jakab must mean that the current price the bonds are trading at is €35.

Step 3: Answer part b. by explaining why the market price of these Austrian century bonds has declined by 65% from their par value even though the bonds have low default risk. As we discuss in this section of the textbook, long-term bonds have substantial interest-rate risk—the risk that the price of the bond will fluctuate in response to changes in market interest rates—even if they have very low default risk—the risk that an investor won’t receive the coupon and principal payments on the bond.  As Table 3.2 in this section shows, the longer the maturity of a bond, the greater the interest-rate risk. As market interest rates on other government bonds have risen, the yield on the Austrian century bonds has also had to rise for investors to be willing to buy these bonds. With a fixed coupon rate of 0.85%, the only way for the yield to rise is for the price of the bonds to fall. Given the very long maturity of these bonds, the price has had to fall by 65% from its par value to make the yield on the bonds competitive with other government bonds.