Roll-Down Return

Roll-Down Return

A roll-down return is the capital appreciation a bond investor can earn as a bond’s maturity shortens and its yield moves down the yield curve—assuming market yields remain relatively stable. It’s an add-on to coupon income that arises from the typical upward-sloping relationship between yield and maturity.

How it works

• The yield curve plots bond yields against maturities. In a normal (upward‑sloping) curve, longer maturities pay higher yields.
• If you buy a longer-dated bond and hold it, the bond “rolls down” the curve as time passes: its maturity shortens and its yield tends to decline toward the yields of shorter-term bonds.
• Because bond prices move inversely to yields, a declining yield increases the bond’s price, generating capital gains in addition to coupon payments.

The magnitude and direction of the roll-down effect depend on the bond’s initial price (discount, par, or premium), the shape of the yield curve, interest rate movements, and the bond’s duration.

Key takeaways

• Roll-down is a yield-curve-based strategy to capture predictable price appreciation as a bond nears maturity.
• It works best with an upward‑sloping yield curve and stable interest rates.
• Risks include rising interest rates, flat or inverted curves, and opportunity cost from alternative investments.

Advantages and disadvantages

Advantages
* Capital appreciation in addition to coupon income when the curve is upward sloping.
* Greater predictability than purely speculative strategies if interest rates are stable.
* A way to manage interest-rate exposure by selecting maturities and positioning on the yield curve.

Disadvantages
* Interest-rate risk: rising rates can erase expected gains or cause losses.
* Dependency on yield-curve shape—flat or inverted curves reduce or reverse the effect.
* Limited upside compared with higher-risk strategies.
* Opportunity cost if better returns are available elsewhere.

Practical example (conceptual)

Suppose you buy a 5‑year bond yielding 3% and plan to hold it for two years. If the yield curve remains upward sloping and overall yields stay stable, the bond’s yield may compress to the level appropriate for a 3‑year maturity. That yield decline lifts the bond’s market price, allowing you to sell at a gain while also collecting coupons during the holding period.

Premium and discount bonds

• Premium bonds (price above par): their higher coupon means market price will amortize toward par as maturity approaches. Amortization reduces total return relative to just coupon receipts; roll-down price gains may be partially offset by this amortization.
• Discount bonds (price below par): roll-down price appreciation and convergence to par can add to returns.

Total return from rolling down a premium or discount bond equals coupon income plus capital gains/losses from price changes, net of any premium amortization.

How to calculate roll-down return

A simple calculation:
roll-down return = (Price_end − Price_start + Coupons_received) / Price_start

Assumptions: the yield curve remains constant in shape, issuer credit risk doesn’t change materially, and yields at each maturity evolve as expected.

Role of duration and credit quality

• Duration: determines sensitivity of bond price to yield changes. Higher duration magnifies roll-down gains and losses; align duration exposure with your interest-rate outlook.
• Credit quality: affects yield level and volatility. Higher-credit bonds are driven more by interest-rate moves; lower-credit bonds may offer higher yields but add credit risk and price volatility.

Related yield-curve strategies

Other approaches to the term structure include:
* Bullet, barbell, and laddered maturity structures
* Spread trades such as butterflies
These strategies are used to target returns and manage risk based on expectations for interest rates and curve shape.

When to use roll-down

Consider a roll-down strategy when:
* The yield curve is positively sloped and expected to remain stable.
* You seek predictable income plus modest capital gains.
* Your interest-rate outlook is neutral or slightly favorable and you can tolerate duration exposure.

Avoid relying on roll-down returns when you expect rising interest rates, an inverted curve, or significant credit deterioration.

Bottom line

Roll-down return is a practical, yield-curve-driven way to enhance fixed-income returns by capturing price appreciation as bonds approach shorter maturities. Its effectiveness hinges on the yield curve’s shape, interest-rate stability, bond duration, and credit considerations. Use it as part of a broader fixed-income plan, mindful of the trade-offs and risks.