Newpoint - What is the value in 2024 of US$42bn payable in 2043? - Part 2

Initial Investment Context:

• Purchase Date: February 15, 2013
• Maturity Date: February 15, 2043
• Initial Investment: $17,016,206,727 est. - see Part 1 article for assumptions

Current Economic Factors:

• 20-Year Treasury Rate: 4.21% (as at now)
• Inflation: Let's assume an average inflation rate over the period from 2013 to 2024 was around 2% annually, which might be conservative but gives us a baseline.

Present Value Calculation:

1. Inflation Adjustment:
   • If inflation averaged 2% per year, over 11.5 years (from 2013 to 2024), the purchasing power of the initial investment would be:
     Adjusted Value=17,016,206,727(1+0.02)11.5≈17,016,206,7271.265≈13,445,630,000
   
   
   This means, due to inflation alone, the real value of your investment has decreased materially ... around $4bn downside.
2. Present Value with Current Interest Rates:
   • Using the 20-year Treasury rate as our discount rate for simplicity, we calculate the present value of the bond's face value at maturity:
     PV=17,016,206,727(1+0.0421)18.25
     Here, we use 18.25 years (from 2024 to 2043) for the remaining term.
   • However, since we're already considering inflation separately, we might adjust this calculation to reflect real terms, but for simplicity, let's use the nominal rate:
     
     
     PV≈17,016,206,7273.48≈4,889,714,300

• Inflation Impact: The initial investment of $17,016,206,727 has, due to inflation, an adjusted value of approximately $13,445,630,000 today. This means inflation has eroded about 21% of the purchasing power of the initial investment over the past 11.5 years.
• Interest Rate Impact: When we calculate the present value using the current 20-year Treasury rate of 4.21%, we get a figure around $4,889,714,300. This drastic reduction from the inflation-adjusted value reflects the time value of money and the bond's yield relative to current market rates.
• Investment Performance:
  • Good Investment: If we consider the bond's yield at the time of purchase (implied by the initial NPV calculation), it was likely higher than the current 4.21% rate. This means the bond was providing a higher return than what's currently available in the market for similar risk and duration investments. From this perspective, locking in that higher yield could be seen as a good move if you hold it to maturity.
  • Bad Investment: However, if you needed to sell the bond today, you'd realize a significant loss due to the rise in interest rates. The bond's price has decreased because newer bonds offer higher yields, making your bond less attractive to investors. This scenario highlights the interest rate risk associated with long-term bonds.

• Interest Rate Sensitivity: Long-term bonds like this one are highly sensitive to interest rate changes. When rates rise, bond prices fall, and vice versa. This bond, being 30 years at purchase, would experience significant price fluctuations with rate changes.
• Holding to Maturity: If you can hold the bond until maturity, you'll get your full $42 billion back (assuming no default), and the yield you locked in at purchase would be realized. This strategy mitigates interest rate risk but requires patience and liquidity.
• Diversification: For a novice investor, putting such a large sum into a single bond, especially one with a long duration, might not be advisable without considering diversification. A mix of investments with different maturities and types could balance risk and return.
• Inflation-Protected Securities: Considering inflation's impact, an investment in inflation-protected securities like TIPS (Treasury Inflation-Protected Securities) might have been a better hedge against inflation for part of the portfolio.
• Opportunity Cost: The money tied up in this bond could have been invested elsewhere, potentially in assets that offer better returns or inflation protection. However, this also comes with different levels of risk.
• Liquidity: Long-term bonds can be less liquid, especially if the market for such bonds is thin. Selling before maturity might not only result in a loss but could also be challenging.