Roll-Down Return

What Is a Roll-Down Return?

A roll-down return is a strategy for expanding a bond's overall yield by taking advantage of the yield curve. It is dependant on the way that the value of a bond merges to par as its maturity date draws near.

The size of the roll-down return fluctuates enormously among long-and short-term dated bonds. Roll-down is more modest for long-dated bonds that are trading away from par compared to short-dated bonds.

Grasping a Roll-Down Return

A bond investor might compute the return on a bond in more than one way. The yield to maturity (YTM) is the rate of return that will be earned assuming the bond is held until it arrives at its maturity date. The current yield is the total in coupon payments owed on the bond at the time it is purchased. The roll-down return is yet one more method of assessing a bond's earnings.

The roll-down return relies upon the state of the yield curve, which is a graphical representation of the yields for various maturities going from one month to 30 years. Accepting that the yield curve is normal, that is up slanting to the right, the rate earned on longer-term bonds will be higher than the yield earned from short-term bonds.

How the Roll-Down Return Works

The roll-down return is, basically, a bond trading strategy for selling a bond as it moves toward its maturity date. As time passes by, a bond's yield falls, and its price rises. Bond investors see greater risk in lending money for a longer time frame period and in this way demand higher interest payments as compensation. Thus, the initial higher interest rate of the long-term bond will decline as its maturity draws near.

The heading of the roll-down relies upon whether the bond is trading at a premium or a discount to its face, or par, value.

By and large, as its maturity date develops closer, a bond's interest rate draws nearer to zero. Since there is an inverse relationship between bond yields and prices, bond prices increase as interest rates decline.

Illustration of a Roll-Down Return

For instance, expect a 10-year Treasury yield is 2.46% and a seven-year yield is 2.28%. Following three years, the 10-year bond will turn into a seven-year bond.

Since the difference in yield between the 10-year and 7-year is 2.46% - 2.28% = 0.18%, the seven-year bond can rise 0.18% more than three years before surpassing the investor's yield to maturity, or at least, 2.46%.

Accepting that interest rates stay something similar, this positive roll means that the price of the bond will go up over the long haul. The roll-down return is the amount that interest rates can rise throughout a predetermined time span before the current yield surpasses an investor's YTM. The investor who sells the bond will get more than they paid for it, notwithstanding the coupon payments that have previously been received.

In effect, the investor is earning money by rolling down the yield curve.

Roll-down return works in two ways. The bearing relies upon whether the bond is trading at a premium or at a discount to its face value.

On the off chance that the bond is trading at a discount, the roll-down effect will be positive. This means the roll-down will pull the price up towards par. In the event that the bond is trading at a premium the contrary will happen. The roll-down return will be negative and pull the price of the bond down back to par.

Features

Generally, a bond's market value draws nearer to its face value as its maturity date draws nearer.
The values of bonds in the secondary market vacillate as interest rates go up or down.
A roll-down return is a bond trading method for selling a bond as it is drawing near to its maturity date when the initial higher interest rate of the long-term bond has declined.
Utilizing the roll-down can take into consideration the highest overall return in light of the yield curve.