Investments, tenth edition

 Example  14.9 

Yield to Maturity versus Holding-Period Return 

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7/17/13   3:51 PM

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  C H A P T E R  

1 4

  Bond Prices and Yields

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branches. The payments are still considered obli-

gations of the U.S. Treasury. The Treasury pro-

gram under which coupon stripping is performed 

is called STRIPS (Separate Trading of Registered 

Interest and Principal of Securities), and these 

zero-coupon securities are called Treasury  strips.  

 What should happen to prices of zeros as time 

passes? On their maturity dates, zeros must sell 

for par value. Before maturity, however, they 

should sell at discounts from par, because of the 

time value of money. As time passes, price should 

approach par value. In fact, if the interest rate is 

constant, a zero’s price will increase at exactly 

the rate of interest. 

 

To illustrate, consider a zero with 30 years 

until maturity, and suppose the market interest 

rate is 10% per year. The price of the bond today 

is $1,000/(1.10) 

30

   5  $57.31. Next year, with only 

29 years until maturity, if the yield is still 10%, 

the price will be $1,000/(1.10) 

29

   5  $63.04, a 10% 

increase over its previous-year value. Because the 

par value of the bond is now discounted for one less year, its price has increased by the 

1-year discount factor. 

  Figure 14.7  presents the price path of a 30-year zero-coupon bond for an annual market 

interest rate of 10%. The bond prices rise exponentially, not linearly, until its maturity.