Skip to ContentGo to accessibility pageKeyboard shortcuts menu
OpenStax Logo
Principles of Finance

12.3 Historical Picture of Returns to Bonds

Principles of Finance12.3 Historical Picture of Returns to Bonds

Menu
Table of contents
  1. Preface
  2. 1 Introduction to Finance
    1. Why It Matters
    2. 1.1 What Is Finance?
    3. 1.2 The Role of Finance in an Organization
    4. 1.3 Importance of Data and Technology
    5. 1.4 Careers in Finance
    6. 1.5 Markets and Participants
    7. 1.6 Microeconomic and Macroeconomic Matters
    8. 1.7 Financial Instruments
    9. 1.8 Concepts of Time and Value
    10. Summary
    11. Key Terms
    12. Multiple Choice
    13. Review Questions
    14. Video Activity
  3. 2 Corporate Structure and Governance
    1. Why It Matters
    2. 2.1 Business Structures
    3. 2.2 Relationship between Shareholders and Company Management
    4. 2.3 Role of the Board of Directors
    5. 2.4 Agency Issues: Shareholders and Corporate Boards
    6. 2.5 Interacting with Investors, Intermediaries, and Other Market Participants
    7. 2.6 Companies in Domestic and Global Markets
    8. Summary
    9. Key Terms
    10. CFA Institute
    11. Multiple Choice
    12. Review Questions
    13. Video Activity
  4. 3 Economic Foundations: Money and Rates
    1. Why It Matters
    2. 3.1 Microeconomics
    3. 3.2 Macroeconomics
    4. 3.3 Business Cycles and Economic Activity
    5. 3.4 Interest Rates
    6. 3.5 Foreign Exchange Rates
    7. 3.6 Sources and Characteristics of Economic Data
    8. Summary
    9. Key Terms
    10. CFA Institute
    11. Multiple Choice
    12. Review Questions
    13. Problems
    14. Video Activity
  5. 4 Accrual Accounting Process
    1. Why It Matters
    2. 4.1 Cash versus Accrual Accounting
    3. 4.2 Economic Basis for Accrual Accounting
    4. 4.3 How Does a Company Recognize a Sale and an Expense?
    5. 4.4 When Should a Company Capitalize or Expense an Item?
    6. 4.5 What Is “Profit” versus “Loss” for the Company?
    7. Summary
    8. Key Terms
    9. Multiple Choice
    10. Review Questions
    11. Problems
    12. Video Activity
  6. 5 Financial Statements
    1. Why It Matters
    2. 5.1 The Income Statement
    3. 5.2 The Balance Sheet
    4. 5.3 The Relationship between the Balance Sheet and the Income Statement
    5. 5.4 The Statement of Owner’s Equity
    6. 5.5 The Statement of Cash Flows
    7. 5.6 Operating Cash Flow and Free Cash Flow to the Firm (FCFF)
    8. 5.7 Common-Size Statements
    9. 5.8 Reporting Financial Activity
    10. Summary
    11. Key Terms
    12. CFA Institute
    13. Multiple Choice
    14. Review Questions
    15. Problems
    16. Video Activity
  7. 6 Measures of Financial Health
    1. Why It Matters
    2. 6.1 Ratios: Condensing Information into Smaller Pieces
    3. 6.2 Operating Efficiency Ratios
    4. 6.3 Liquidity Ratios
    5. 6.4 Solvency Ratios
    6. 6.5 Market Value Ratios
    7. 6.6 Profitability Ratios and the DuPont Method
    8. Summary
    9. Key Terms
    10. CFA Institute
    11. Multiple Choice
    12. Review Questions
    13. Problems
    14. Video Activity
  8. 7 Time Value of Money I: Single Payment Value
    1. Why It Matters
    2. 7.1 Now versus Later Concepts
    3. 7.2 Time Value of Money (TVM) Basics
    4. 7.3 Methods for Solving Time Value of Money Problems
    5. 7.4 Applications of TVM in Finance
    6. Summary
    7. Key Terms
    8. CFA Institute
    9. Multiple Choice
    10. Review Questions
    11. Problems
    12. Video Activity
  9. 8 Time Value of Money II: Equal Multiple Payments
    1. Why It Matters
    2. 8.1 Perpetuities
    3. 8.2 Annuities
    4. 8.3 Loan Amortization
    5. 8.4 Stated versus Effective Rates
    6. 8.5 Equal Payments with a Financial Calculator and Excel
    7. Summary
    8. Key Terms
    9. CFA Institute
    10. Multiple Choice
    11. Problems
    12. Video Activity
  10. 9 Time Value of Money III: Unequal Multiple Payment Values
    1. Why It Matters
    2. 9.1 Timing of Cash Flows
    3. 9.2 Unequal Payments Using a Financial Calculator or Microsoft Excel
    4. Summary
    5. Key Terms
    6. CFA Institute
    7. Multiple Choice
    8. Review Questions
    9. Problems
    10. Video Activity
  11. 10 Bonds and Bond Valuation
    1. Why It Matters
    2. 10.1 Characteristics of Bonds
    3. 10.2 Bond Valuation
    4. 10.3 Using the Yield Curve
    5. 10.4 Risks of Interest Rates and Default
    6. 10.5 Using Spreadsheets to Solve Bond Problems
    7. Summary
    8. Key Terms
    9. CFA Institute
    10. Multiple Choice
    11. Review Questions
    12. Problems
    13. Video Activity
  12. 11 Stocks and Stock Valuation
    1. Why It Matters
    2. 11.1 Multiple Approaches to Stock Valuation
    3. 11.2 Dividend Discount Models (DDMs)
    4. 11.3 Discounted Cash Flow (DCF) Model
    5. 11.4 Preferred Stock
    6. 11.5 Efficient Markets
    7. Summary
    8. Key Terms
    9. CFA Institute
    10. Multiple Choice
    11. Review Questions
    12. Problems
    13. Video Activity
  13. 12 Historical Performance of US Markets
    1. Why It Matters
    2. 12.1 Overview of US Financial Markets
    3. 12.2 Historical Picture of Inflation
    4. 12.3 Historical Picture of Returns to Bonds
    5. 12.4 Historical Picture of Returns to Stocks
    6. Summary
    7. Key Terms
    8. Multiple Choice
    9. Review Questions
    10. Video Activity
  14. 13 Statistical Analysis in Finance
    1. Why It Matters
    2. 13.1 Measures of Center
    3. 13.2 Measures of Spread
    4. 13.3 Measures of Position
    5. 13.4 Statistical Distributions
    6. 13.5 Probability Distributions
    7. 13.6 Data Visualization and Graphical Displays
    8. 13.7 The R Statistical Analysis Tool
    9. Summary
    10. Key Terms
    11. CFA Institute
    12. Multiple Choice
    13. Review Questions
    14. Problems
    15. Video Activity
  15. 14 Regression Analysis in Finance
    1. Why It Matters
    2. 14.1 Correlation Analysis
    3. 14.2 Linear Regression Analysis
    4. 14.3 Best-Fit Linear Model
    5. 14.4 Regression Applications in Finance
    6. 14.5 Predictions and Prediction Intervals
    7. 14.6 Use of R Statistical Analysis Tool for Regression Analysis
    8. Summary
    9. Key Terms
    10. Multiple Choice
    11. Review Questions
    12. Problems
    13. Video Activity
  16. 15 How to Think about Investing
    1. Why It Matters
    2. 15.1 Risk and Return to an Individual Asset
    3. 15.2 Risk and Return to Multiple Assets
    4. 15.3 The Capital Asset Pricing Model (CAPM)
    5. 15.4 Applications in Performance Measurement
    6. 15.5 Using Excel to Make Investment Decisions
    7. Summary
    8. Key Terms
    9. CFA Institute
    10. Multiple Choice
    11. Review Questions
    12. Problems
    13. Video Activity
  17. 16 How Companies Think about Investing
    1. Why It Matters
    2. 16.1 Payback Period Method
    3. 16.2 Net Present Value (NPV) Method
    4. 16.3 Internal Rate of Return (IRR) Method
    5. 16.4 Alternative Methods
    6. 16.5 Choosing between Projects
    7. 16.6 Using Excel to Make Company Investment Decisions
    8. Summary
    9. Key Terms
    10. CFA Institute
    11. Multiple Choice
    12. Review Questions
    13. Problems
    14. Video Activity
  18. 17 How Firms Raise Capital
    1. Why It Matters
    2. 17.1 The Concept of Capital Structure
    3. 17.2 The Costs of Debt and Equity Capital
    4. 17.3 Calculating the Weighted Average Cost of Capital
    5. 17.4 Capital Structure Choices
    6. 17.5 Optimal Capital Structure
    7. 17.6 Alternative Sources of Funds
    8. Summary
    9. Key Terms
    10. CFA Institute
    11. Multiple Choice
    12. Review Questions
    13. Problems
    14. Video Activity
  19. 18 Financial Forecasting
    1. Why It Matters
    2. 18.1 The Importance of Forecasting
    3. 18.2 Forecasting Sales
    4. 18.3 Pro Forma Financials
    5. 18.4 Generating the Complete Forecast
    6. 18.5 Forecasting Cash Flow and Assessing the Value of Growth
    7. 18.6 Using Excel to Create the Long-Term Forecast
    8. Summary
    9. Key Terms
    10. Multiple Choice
    11. Review Questions
    12. Problems
    13. Video Activity
  20. 19 The Importance of Trade Credit and Working Capital in Planning
    1. Why It Matters
    2. 19.1 What Is Working Capital?
    3. 19.2 What Is Trade Credit?
    4. 19.3 Cash Management
    5. 19.4 Receivables Management
    6. 19.5 Inventory Management
    7. 19.6 Using Excel to Create the Short-Term Plan
    8. Summary
    9. Key Terms
    10. Multiple Choice
    11. Review Questions
    12. Video Activity
  21. 20 Risk Management and the Financial Manager
    1. Why It Matters
    2. 20.1 The Importance of Risk Management
    3. 20.2 Commodity Price Risk
    4. 20.3 Exchange Rates and Risk
    5. 20.4 Interest Rate Risk
    6. Summary
    7. Key Terms
    8. CFA Institute
    9. Multiple Choice
    10. Review Questions
    11. Problems
    12. Video Activity
  22. Index

Learning Outcomes

By the end of this section, you will be able to:

  • Detail the behavior of sovereign (government) bonds over various historical periods.
  • Detail the behavior of corporate bonds over various historical periods.
  • Extract sovereign and corporate bond investment results from plots and charts.

Federal Government Bond Behavior, Discussion, Charts, and Graphs

United States Treasury (sovereign) bonds are among the safest investments available. In fact, T-bonds often serve as the proxy for a risk-free investment in financial modeling. However, even though T-bonds may be essentially default-risk free, they do change value as interest rates change. Look at Figure 12.8, showing annual T-bond returns from 1980 to 1999. None of these bonds defaulted, yet investors realized very different returns on their investments from year to year. The total returns reflect interest payments plus the change in price because of changes in interest rates.

The late 1970s experienced high rates of inflation and interest rates. As those rates began to fall in late 1981, bond prices rose. Investors holding T-bond portfolios realized very large returns on their risk-free investments in 1982. That year provided the highest annual return in the 20-year period, with an annual return of 32.81%. The lowest annual return was in 1999, as the Federal Reserve began to raise rates to temper an overheating stock market caused by dot-com speculation gaining momentum. When the Fed raised interest rates, the prices on existing bonds fell, and investors realized a -8.25% return on their bond portfolios. Thus, the range in returns on these “low risk” investment securities was over 41% from the highest to the lowest annual return in this particular two-decade span. Overall, the average annual return on T-bonds from 1980 to 1999 was a robust 10.21%, boosted in part by the above average annual inflation rate of 4.28%.

A bar graph that shows the average annual returns of the Treasury Bond Performance from 1980 to 1999. It is seen that the Treasury Bonds recorded negative returns in 1980, 1987, 1994, and 1999. The highest return of 32.81% is recorded in 1982, while the lowest return of -8.25% was recorded in 1999. The average annual return displayed is 10.21%.
Figure 12.8 Treasury Bond Performance, 1980–1999 (data source: Aswath Damodaran Online)

Inflation slowed from 2000 to 2020, and the average annual rate of return on T-bonds fell accordingly (see Figure 12.9). With reduced variability of interest rates in the new century and interest rates in general being lower, the returns on bond portfolios were also lower on average. T-bonds in the first two decades of the twenty-first century averaged an annual return of 5.77%, very close to the long-run average return in the previous century. The range of returns was also smaller than the previous two decades, with the highest annual return topping out at 20.10% in 2008 and the lower end dipping down to -11.12% in 2009 as the Fed made a significant effort to reduce interest rates in an attempt to stimulate the economy following the Great Recession.

Corporate Bond Behavior, Discussion, Charts, and Graphs

The performance of Baa bonds is very similar to T-Bonds over the four decades spanning 1980 to 2020 (see Figure 12.10). These bonds are not default-risk free and require a risk premium for investors. The average annual return of 12.07% from 1980 to 1999 topped T-bonds by 1.86%. The margin was greater in the period from 2000 to 2020 (see Figure 12.11), with Baa bonds (mid-tier corporate bonds) realizing an average annual premium of 2.30% over the default-risk free T-bonds.

These premiums translate to a substantial increase in investment performance. For example, had an investor placed $100 into a T-bond portfolio in 1980, the value of the investment would have been $1,931 by year-end 2020. This would have easily outpaced the rate of inflation but significantly lagged the ending value of $4,506 on a similar Baa bond portfolio investment (see Figure 12.12).

A bar graph that shows the average annual returns of the Treasury Bond Performance from 2000 to 2020. It is seen that the Treasury Bonds recorded negative returns in 2009 and 2013. In 11 out of the 20 years, the rate of return was 5% or less.
Figure 12.9 Treasury Bond Performance, 2000–2020 (data source: Aswath Damodaran Online)
A bar graph that shows the average annual returns of the Baa Bond Performance from 1980 to 1999. It is seen that the Treasury Bonds recorded negative returns in 1980 and 1994. The highest return of 29.05% is recorded in 1982, while the lowest return of -3.32% was recorded in 1980. The average annual return displayed is 12.07%.
Figure 12.10 Baa Bond Performance, 1980–1999 (data source: Aswath Damodaran Online)
A bar graph that shows the average annual returns of the Baa Bond Performance from 2000 to 2020. The Treasury Bonds recorded negative returns in 2008, 2013, 2015, and 2018. The highest return of 23.33% is recorded in 2009, while the lowest return of -5.07% was recorded in 2008. The average annual return displayed is 8.04%.
Figure 12.11 Baa Bond Performance, 2000–2020 (data source: Aswath Damodaran Online)
The two lines on the graph show the performance of Baa Bonds and T-Bonds over a 40 year period from 1980 to 2020. Starting in 1988, the Baa Bonds begin to outperform T-bonds. Baa bonds dip slightly in 2008 before rising exponentially, while T-Bonds rise slightly in 2008 before returning to their previous trajectory.
Figure 12.12 Baa Bonds versus T-Bonds Performance, 1980–2020 (data source: Aswath Damodaran Online)

Concepts In Practice

Profile of Bill Gross

Bill Gross may be the most successful fixed-income investor ever, but he is also a prime example of the application of the efficient market theory. In over 40 years of investing in bonds and other types of fixed-income securities worldwide, Bill Gross earned his moniker “the bond king.”

In 1971, Gross cofounded and began his long tenure as managing director and chief investment officer of Pacific Investment Management Company, better known as Pimco. Gross was not yet 30 years old, but he had already graduated from college, served in the Navy in Vietnam, and even briefly worked as a professional blackjack player in Las Vegas to bankroll the cost of his MBA from UCLA.

Gross helped change the definition of success for bond investors by focusing on total returns, including price changes, rather than simply bond yields. He used mathematical modeling and invested worldwide and in different types of bond markets seeking risk-adjusted returns. Gross made active rather than passive management of bond funds a successful investment strategy. In the process, he changed how mangers oversee fixed-income portfolios today.

Pimco grew into an investment powerhouse under Gross’s direction, eventually managing over $1.5 trillion dollars in assets. During the financial crisis of 2008, Gross served as an adviser to the US Treasury. Morningstar named him “fixed income fund manager of the decade” in 2010. In addition, Gross profited from his investment prowess, amassing a fortune in excess of $2 billion.

Gross’s investment strategy was to carefully analyze the known factors about debt instruments and pair that analysis with the unknown future. He was uncanny in his ability to estimate future prices, interest rates, and macroeconomic conditions to make profitable investments.

However, as efficient markets would posit, the odds began to catch up with Gross in the latter part of his investing career. After leaving Pimco in 2014, Gross was unable to match his earlier performance successes and failed to beat bond fund performance averages. Much of Gross’s investment strategy allowed him to look for bond returns by investing in any type of bond, with any maturity, in any country, and in any location. For decades, he was right more often than wrong in his investment choices. However, statistically, his approach to investing suggested that, unless he could see the future, at some point his expectations would be incorrect. Perhaps Gross’s greatest competition comes from a generation of investment managers who learned and improved upon his proven strategies. He retired as an active public fund manager in 2019.

Today, Gross continues to manage his personal fortune, as well as the assets in his family charitable foundation. Gross and the foundation have donated over $800 million to several causes over the last two decades. In 2020, Gross joined Bill Gates, Warren Buffett, and hundreds of other billionaires in signing the Giving Pledge, whose signees promise to donate over 50% of their wealth during their lifetime and/or upon their death.

(Sources: Mary Childs. “Bill Gross Made the Bond Market What It Is Today.” Barron’s. February 8, 2019. https://www.barrons.com/articles/bill-gross-bond-market-investing-legacy-51549669974; Jeff Sommer. “Once the ‘Bond King,’ Bill Gross Is Retiring, His Star Dimmed.” New York Times. February 4, 2019. https://www.nytimes.com/2019/02/04/business/bond-king-bill-gross-retirement.html; CNN. “Bill Gross Fast Facts.” CNN. March 31, 2021. https://www.cnn.com/2013/04/08/us/bill-gross-fast-facts/)

Do you know how you learn best?
Kinetic by OpenStax offers access to innovative study tools designed to help you maximize your learning potential.
Order a print copy

As an Amazon Associate we earn from qualifying purchases.

Citation/Attribution

Want to cite, share, or modify this book? This book uses the Creative Commons Attribution License and you must attribute OpenStax.

Attribution information
  • If you are redistributing all or part of this book in a print format, then you must include on every physical page the following attribution:
    Access for free at https://openstax.org/books/principles-finance/pages/1-why-it-matters
  • If you are redistributing all or part of this book in a digital format, then you must include on every digital page view the following attribution:
    Access for free at https://openstax.org/books/principles-finance/pages/1-why-it-matters
Citation information

© May 20, 2022 OpenStax. Textbook content produced by OpenStax is licensed under a Creative Commons Attribution License . The OpenStax name, OpenStax logo, OpenStax book covers, OpenStax CNX name, and OpenStax CNX logo are not subject to the Creative Commons license and may not be reproduced without the prior and express written consent of Rice University.