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Just a quick approximation of what a 4.5% 30-year T-Bond would be worth in 5 years under different prevailing interest rate scenarios:

If rates dropped to 3%, you could sell a $1000 bond for about $1395, which combined with 4.5% over the first 5 years would give you an annualized return of about 8.3%

If rates went up to 6% and you had to sell, you would get about $605 of your $1000 face value back.

If rates went up to 8% and you had to sell, you would get about $75 for your bond (an 8% bond over 25 years would earn almost $1000 more, after compounding than a 4.5% bond),

Using a straight line, no compounding, no FV, these values seem farfetched to me. It seems to me that from a current income perspective, that 4.5% bond at 3% prevailing rates would be worth about $1500, and that same 4.5% bond at 8% prevailing rates would be worth $562.50 (not $75). Am I missing something (other than compounding)?

Hope this puts risk/reward into perspective. Even if rates did drop to 3%, returns would not come close to the 14% plus of bonds bought in '81 or '82. If rates rise, which, contrarian thinking aside, is a scenario supported by more factors over the medium to long term, the best that can hoped for is sitting on a 4.5% bond for 30 years.

I think the risk/reward must also account for the likelihood of either scenario. It seems to me that the 8% scenario is more likely than the 3% scenario for long bonds. Of course, many folks disagree, and I've been wrong before.

Mark [not a bond expert, not even a bond novice]
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