The Bank That Bought the Safest Thing - bond prices, yield and duration

The board’s jargon line says a bond’s yield is “what a bond pays, as a rate on today’s price”. This lesson shows why that rate and the price move in opposite directions, and how a bank that bought the safest promises in the valley was sunk by it.

Education, not financial advice.

Before you start. From Why a Coin Today Beats a Coin Next Year - present value and discounting you need discounting: money promised later is worth less today, and the higher the going interest rate, the less it is worth. From Owning a Slice of the Ship - shares, bonds, and who gets paid first you need that a bond is a loan with a schedule: a fixed payment every year, then the original sum back at the end. From What the Valley Pays You to Carry the Drought - risk premium, beta, CAPM and the Sharpe ratio, the safe well: lending to a government is about as close to risk-free as lending gets.

The idea in 30 seconds

A bond is a promise to pay a fixed coupon every year and the full sum at the end. Most of Silicon Valley Bank’s bonds were about as safe from default as promises get.
Yield is what a bond pays as a rate on today’s price. When the going rate rises, an old bond’s price falls until its yield matches: price and yield move opposite.
Duration is the lever: roughly the percentage a bond’s price falls per one-point rise in rates. Long bonds have big durations; a one-year bond barely moves.
The bank bought long bonds (average duration 6.2 years) with deposits that could leave any day. When rates rose in 2022, the bonds lost value without defaulting.
Selling to meet withdrawals turned a paper loss into a real one, $1.8 billion on 8 March 2023, and the run that followed closed the bank on 10 March.
Interest-rate risk is separate from default risk: “safe from default” is not “safe”.

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