Yield and risk move hand in hand. look similar in risk, but one has a lower price and, therefore, higher yield, there is some difference in the amount of liquidity, credit or interest rate risk. Sometimes the difference in risk is clear, and sometimes, it can be hiding a little bit. 3. Interest rate risk is a two-sided coin. I teach several banking schools where I like to ask this trick question: Which has more interest rate risk, a three-month Treasury bill or a 10-year Treasury bond? Most of the students tend to pick the 10-year Treasury bond because it has a longer maturity and, therefore, longer duration than a three-month Treasury bill. They both have interest rate risk but different types. The reinvestment risk of a three-month Treasury bill is higher than a 10-year Treasury bond due to its maturing every three months with the investor subject to market rate movements over that three-month period. The 10-year has more long-term interest rate risk or price risk. If the 10-year Treasury bond is held for the entire 10-year period, the yield will not change. However, the unrealized gain or loss (value) will fluctuate based on the movement of market rates. Understanding this dynamic in fixed-income investing is important, especially in times when the inverted yield curve is tricking you into keeping a lot of your dollars in the shorter part of the curve. Late-cycle investing typically involves moving towards protecting the yield or income of the portfolio versus the value of the portfolio. 4. There are good ways and bad ways to extend duration. Traditional late-cycle fixed-income investment strategies typically involve some level of extension of duration to ensure the “locking” in of yield over a longer period. 27 NEBRASKA BANKER
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