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What Is a Benchmark Bond?

Jim B.
Jim B.

A benchmark bond is a bond issued by a government or central economic body intended to act as the standard for all similar bonds. In most cases, the benchmark is the latest issuance of a certain type of bond, creating the new basis of comparison for all other similar bonds. It is wise to compare the performance of a benchmark bond to other bonds that are similar in terms of time to maturity, interest rate, and liquidity. Most benchmark bonds yield relatively small returns on investment, allowing for other bonds in the market to be judged by the amount that they exceed those benchmarks.

Bond investors are usually interested in effective ways of judging the performance of their bonds. This can be difficult to achieve with the sheer number of bonds available. These bonds can differ in many ways, making comparison between various bonds nearly impossible. For that reason, having a standard to use as the basis for all other bonds of the same ilk is especially helpful to bond investors. A benchmark bond can serve this important purpose.

Man climbing a rope
Man climbing a rope

On most occasions, a benchmark bond is issued by a government or the central bank of a specific country. Since these bonds are backed up by the treasuries of the countries in question, there is very little chance that their will be any sort of default. For that reason, the yields that can be reaped from these bonds are relatively small. In the bond market, safe instruments are usually accompanied by low interest rates, and interest rates ultimately determine bond yields.

There can be many differences between one benchmark bond and another. Each bond has different characteristics that distinguish it. Chief among these are the coupon, which is the interest rate offered to the investor, the maturity, which is the amount of time before the principal is repaid, and the liquidity, which is the ease, or lack thereof, that these bonds can be bought and sold. When governments make the latest issue of a bond of a certain maturity, it becomes the new benchmark.

Once the new benchmark bond is issued, comparisons can be made between its performance and the performance of other similar bonds in the market. Most bonds are judged by their yield, which is essentially the return on investment that the bond gains the investor over time. Seeing how bonds stack up against each particular benchmark can give investors an idea of which ones are the most valuable.

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