What Is a Benchmark Bond?
A benchmark bond is a bond that gives a standard against which the performance of other bonds can be measured. Government bonds are almost consistently utilized as benchmark bonds, for example, on-the-run U.S. Treasuries.
A benchmark bond is sometimes alluded to act as an illustration of a benchmark issue or bellwether issue.
How Benchmark Bonds Work
Benchmark equity, similar to the S&P 500 or Dow Jones Industrial Average (DJIA), is utilized to track the performance of company stocks trading on the markets. Stock investors can run a comparison of a company's shares with comparative equity in the benchmark to understand what level the company's shares are performing at. The concept of a benchmark bond is like benchmark equity, but a benchmark bond works in a slightly different manner.
Essentially, the benchmark bond is a security which the prices of other bonds react to. Bond investors and fund managers utilize the benchmark bond as a yardstick for measuring bond performance and to understand what rate of return to demand in excess of the benchmark return. For a comparison to be appropriate and helpful, the benchmark and the bond being measured against it ought to have comparable liquidity, issue size, and coupon. For instance, the 10-year US Treasury bond is mostly utilized as a benchmark for 10-year bonds in the market. Since Treasury securities are considered to be riskless investments guaranteed by the full faith and credit of the US government, these securities offer a risk-free return. An investor that wants to check the return for a 10-year corporate bond, which most possible has more risk than a government bond, will compare the yield to the 10-year Treasury bond. In the event that the yield on a 10-year T-bond is going for 2.85%, the investor will demand a risk premium above 2.85% from the corporate bond issuers.
All the more explicitly, the benchmark bond is the latest issue within a given maturity. While the characteristics of the bond determine the decision viewing what equity to incorporate as a benchmark is made by a committee keeping broad guidelines about the operations of the companies represented by a benchmark index, including a benchmark bond or supplanting one benchmark bond with another. Characteristics incorporate maturity date, credit rating, issue size, and liquidity. A bond that meets the stated criteria is incorporated as a benchmark. In addition, on the rebalance date, which could change the bond index constituents, bonds done meeting the index criteria will be eliminated, and any new bonds that really do meet the criteria will be added.
Instances of Benchmark Bonds
The Treasury, for instance, issues and yet again issues 5-year bonds, utilized as a benchmark bond for 5-year bonds, on a frequent basis. As months and years go by, the 5-year bond maturity date lessens to 4.5, 4, 3.8, 3.7, 3 years, etc, until it arrives at its maturity date. Be that as it may, in a normal interest rate environment, bond yields go down as the bond approaches maturity. In effect, longer-term bonds have higher yields than shorter-term bonds. Therefore, a benchmark that approaches maturity will be valued at progressively lower yields. To bring the yield back up, the government will issue another 5-year bond. This latest issue will supplant the more established issue as the benchmark bond for 5-year bonds.
- Like benchmarking stock performance against an equity index, a benchmark bond is utilized to measure the performance of fixed income investments or portfolio managers.
- A benchmark bond is a standard measure of a bond's risk or return against which other bonds are measured.
- Benchmark bonds are typically on-the-run Treasuries, since these are considered the most exceptionally rated and liquid debt.