Do bonds have a theoretical limit in price?

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Old Dec 19, 2011, 9:41pm   #1
Joined Oct 2011
Do bonds have a theoretical limit in price?

Hi All,

I am not sure where to place this question, so I am asking it in this section.

Let's look at U.S. 20+ year Treasury bonds. Most of them are trading above par value of 100 (102-109 range) with some as high as 132(e.g. T-TIPS 15-Apr-2032). This is 32% over the guaranteed value of the bond - an investor who bought it for 132 will only get 100 at maturity - a sure loss.
The interest on the bond is 3.375% (nominal), so the best an investor can get is 3.375/year * 30 = 101.35 in interest over 30 years. that would double the par value but with 32% premium it is only 69% or 2.5%/year. The real return is probably already below zero if we factor inflation in.

With that math in mind, what would a highest possible price of bond be ? Is it par value plus all interest paid till maturity (100+101.35=201.35 in this example)? Does it mean bond funds like TLT can go up another 50% or so?

Thanks
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Old Dec 19, 2011, 11:06pm   #2
 
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Re: Do bonds have a theoretical limit in price?

Unlimited.
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Old Dec 20, 2011, 4:04am   #3
 
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Re: Do bonds have a theoretical limit in price?

You're not thinking of it straight, especially where TIPS's are concerned. 132 for the 4/32 TIPS is the current *clean* price. For TIPS the cash flows (both coupons and redemption) are not as straightforward as you calculate them to be. Even w/nominal bonds your logic is severely flawed.

Let's leave TIPS aside to avoid confusion. Taking just nominals, a yield of 0 is sort of a hard floor in a majority of cases (not 100% true all the time). Current yield on the CTD for the H2 long bond contract (2027 maturity) is arnd 2.37%. A yield of 0 would imply a price that's arnd 38 points higher, if my arithmetic is correct. The realistic ceiling is a lot lower, probably.
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Old Dec 20, 2011, 8:47am   #4
 
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Re: Do bonds have a theoretical limit in price?

BTW, not sure where you get the price for 4/32 TIPS, but in the mkt it's actually arnd 156 (again, this is the *clean* price).
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Old Dec 20, 2011, 4:04pm   #5
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Re: Do bonds have a theoretical limit in price?

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BTW, not sure where you get the price for 4/32 TIPS, but in the mkt it's actually arnd 156 (again, this is the *clean* price).
I got the price from Yahoo Bond Screener. Found more expensive bonds there after I posted my question.
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Old Dec 20, 2011, 4:05pm   #6
 
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Re: Do bonds have a theoretical limit in price?

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I got the price from Yahoo Bond Screener. Found more expensive bonds there after I posted my question.
Yep, but looking at bond prices isn't gonna get you very far... They're largely meaningless. In fact, I am long the 4/32 TIPS, 'cause it's a relatively cheap bond, regardless of the high coupon/clean price (it's cheap, because it's a small issue and it's perceived to be less liquid than the others).
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Old Dec 20, 2011, 4:27pm   #7
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Re: Do bonds have a theoretical limit in price?

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Yep, but looking at bond prices isn't gonna get you very far... They're largely meaningless. In fact, I am long the 4/32 TIPS, 'cause it's a relatively cheap bond, regardless of the high coupon/clean price (it's cheap, because it's a small issue and it's perceived to be less liquid than the others).
If bonds sell off like they did in the beginning of 2009 (look at TLT chart for guidance), what would happen to 4/32 TIPS? How much down would it go?
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Old Dec 20, 2011, 4:41pm   #8
 
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Re: Do bonds have a theoretical limit in price?

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If bonds sell off like they did in the beginning of 2009 (look at TLT chart for guidance), what would happen to 4/32 TIPS? How much down would it go?
Who knows? It very much depends on what makes the bonds sell off and by how much... In 2009, 4/32 TIPS was actually quite stable while TLT was falling off the cliff. You have to remember that a TIPS isn't exactly like your normal nominal bond. It's got an extra moving part.
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Old Dec 20, 2011, 8:00pm   #9
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Re: Do bonds have a theoretical limit in price?

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Who knows? It very much depends on what makes the bonds sell off and by how much... In 2009, 4/32 TIPS was actually quite stable while TLT was falling off the cliff. You have to remember that a TIPS isn't exactly like your normal nominal bond. It's got an extra moving part.
May be TIPS is a bad example. TLT is comprised of 20+ years to maturity U.S. Treasury bonds other than TIPS. Does TLT price reflect an average price of these bonds with $100 being a par value? Does TLT have a logical upper price limit?
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Old Dec 20, 2011, 10:16pm   #10
 
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Re: Do bonds have a theoretical limit in price?

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May be TIPS is a bad example. TLT is comprised of 20+ years to maturity U.S. Treasury bonds other than TIPS. Does TLT price reflect an average price of these bonds with $100 being a par value? Does TLT have a logical upper price limit?
Yeah, let's leave TIPS out of this... And yes, you could kinda sorta say that TLT reflects an "average" price of the bonds in the index.

Generally, as I mentioned earlier, zero yield is probably the real hard bound and that sorta kinda (using very rough estimates, since I don't know the exact duration of the index) means potentially 38 extra points. If you assume that the lowest things can get to is where Japanese bonds trade at the moment, rather than zero (not too unreasonable of an assumption) it's more like extra 15 points.
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