Taking Disneys 100-year Sleeping Beauty Bond issue as a motivating example, we aim to analyze whether such century bonds are merely a novelty item or an indicator of a long term trend in investment management.

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Introduction

100-year bonds form a niche market, with companies and investors perennially trying to weigh the pros and cons of such very long-term debts. 44 such bonds were issued during the 90s (Exhibit 1), probably as a response to a drop in the yields on Baa corporate bonds to between 7% and 8% from a local high of approximately 10% in 1990.  Taking Disney’s 100-year “Sleeping Beauty” Bond issue as a motivating example, we aim to analyze whether such century bonds are merely a novelty item or an indicator of a long term trend in investment management.

100-year bonds: Advantages to investors

The majority of buyers of such bonds are insurance companies and pension funds. This is because the very-long term income stream that these bonds offer is a good match for investors with very-long term liabilities. The long duration of century bonds helps these institutions to reduce their asset/liability mismatch while their exposure to interest rate risk is offset by the long duration of their liabilities. Also, buying such bonds is a good way for such institutions to immunize their portfolio from interest rate risk, since the long-term stream of income helps them match their long-term cash outflows.

The biggest advantage of 100-year bonds is their tremendous convexity. As shown in Exhibit 2, Sleeping Beauty has a much larger convexity than Napping Beauty, which is identical to it except for a shorter maturity. That is to say, the relative rise in price of Sleeping Beauty compared with Napping Beauty given a downside shock in interest rates is significantly higher than the relative fall in Sleeping Beauty’s price when interest rates rise by the same amount. Generally speaking, a 100-year bond will significantly outperform a 10-year bond with the same coupon rate when yields fall, while it will underperform a 10-year bond to a much lesser extent if yields rise by the same amount.

Risk Factors

However, given their extremely long maturity, the risk taken by the bondholders is much greater than that of a holder of a 30-year or less bond. The primary reason for that is the much greater sensitivity of a century bond to changes in the bond yield; that is to say, its duration is usually very large. The great exposure of century bonds to interest rate risk is demonstrated by the results of question 4 in the attached excel file. An increase of the interest rate by 10 base points provokes a 1.32% decrease in the price of the bond, almost two times the decrease that the same change in the interest rates would cause to the price of a similar 10-year bond. Hence, the interest rate risk is quite high. Despite the fact that formally century bonds are a form of debt, some would claim that from a riskiness point of view they are closer to equity securities.

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Advantages to issuers

Studies about the century bonds that have been issued indicate some common characteristics about their issuers. To begin with, these bonds do not have sinking fund requirements [1]. This is an indication that the firms issuing such bonds are large institutions, exhibiting more publicly available information and, therefore, low information asymmetry.  At the same time, a sinking fund requirement could effectively reduce the maturity of such a bond, contradicting the original intentions of issuing such a long-term debt. Studies such as Diamond [5], [6] and Stiglitz & Weiss [7] indicate that firms have incentives to ...

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