A human: 85 years. A Galapagos turtle: 400+. A bond portfolio? All over the map.
So you're buying into a mutual fund carrying bonds only rated BBB. Because they're somewhat risky, they carry an interest rate premium, which makes you happy. But you're worried about inflation taking off in three or four years, so you care a lot about the average life of the bonds in the portfolio. If the average life was two and a half years, and most of the bonds came due in four years or less, then you could probably sleep like a baby every night.
But if the average life is more like 15, 16, 20 or 30 years, then if inflation hits in just four years, those bonds will go down a ton.
The other name for average life is "weighted average maturity," or "weighted average life." So what is being weighed here? Answer: the dollar amount of the principal of the bond. That is, you could have a portfolio with just three bonds. One is a billion dollars, another is ten million, and another is two million. Well, the vast majority of this portfolio's value will be driven by that billion-dollar bond. It carries an extremely high weighting in this average life calculation.
Related or Semi-related Video
Finance: What are High Yield/Junk Bonds?19 Views
finance a la shmoop. what are high-yield or junk bonds? alright well here are low
yield bonds, you know Apple Microsoft you know, safe secure sleep [charts]
like a baby even for Chicken Little those kind of bonds. the sky is not
falling. all right well here are high-yield bonds Sears you know Toys R
Us aren't they bankrupt already best buy well someday bankrupt ,yeah not safe not
secure, the sky among other things like credit ratings is in fact falling. well [definitions on screen]
why do high-yield bonds yield a lot that is they pay a lot of interest to
investors why do they do that answer because they have to. right but
why why do they have to? well because the bonds are risky either the business is
in danger of dying, or the business has borrowed so much money that it's in [ best buy pictured]
danger of not being able to pay back the loans. that is their operating profit is
just barely enough to pay the interest costs on all the loans they've borrowed
so the risk of default is high and investors demand very high interest for
taking on the risk of having to go through a potential bankruptcy. the term
junk was coined in the 1980s when the now-defunct investment bank Drexel [100 dollar bill]
Burnham Lambert sold boatloads of bonds which had dubious creditworthiness in
weak backing and so the boatloads of bonds sank and ended up as basically
junk. and not the Chinese junk that actually sales, a different kind of junk.
anyway unlike your fancy triple-a bonds which you can see here on this lovely [ boat sails on a lake]
table ,those junk bonds were riskier than us women in shark-infested waters with a
bloody nose. so what's the best way to encourage people to do risky possibly
dangerous things ?well pay them a lot of money. so that's why junk bonds yield
such killer returns for investors because otherwise well these things [two people frown in front of bond store]
would never leave the shelf.
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