Bullet Strategy: Bonds for One Date
A bullet strategy holds bonds that all mature at or near the same date, chosen because the money is needed then. It matches an asset to a known future liability, which makes the price movements in between largely irrelevant and leaves credit risk as the exposure that survives.
How it works
Several bonds are bought, all maturing at or near the same time. They may be purchased at different moments and at different yields, but they are chosen so the money returns together.
The date comes first and the bonds are chosen to fit it. School fees, a purchase, the start of retirement — the structure exists because there is a known obligation at a known time.
This is asset-liability matching, and it is a different objective from investing. The aim is that a specific sum exists on a specific day. Return is a constraint, not the goal — which is why the approach looks unambitious until you notice what it is actually being asked to do.
A ladder is the opposite design. It staggers maturities so something matures every year, producing a steady stream and spreading reinvestment across the cycle. A bullet does the reverse deliberately, because the need is not spread out.
What you are accepting
Concentration is the trade-off. When the bonds mature, whatever rates exist on that day are the rates available. A ladder averages across many such days; a bullet takes one. If the money is being spent rather than reinvested, that concentration costs nothing.
The purchases are usually spread even though the maturities are not. Buying into the same maturity over several years averages the entry yield, which is the mirror image of the reinvestment problem and partially answers it.
Credit risk is the one thing the structure cannot remove. Interest-rate movement stops mattering if you hold to maturity; a default still does. The whole design rests on the issuer paying, which is why government and high-grade issues dominate these portfolios.
In practice
Dealing costs more than in equities. Bond markets are quote-driven and less transparent, so the spread is wider — which is another reason a buy-and-hold structure suits the instrument.
Most individual bonds are illiquid by design. They are bought by holders who intend to keep them, so volume between issue and maturity can be close to nothing.
Time is not a risk here; it is the specification. The holding period was decided before anything was bought, and it is the same length as the obligation.
A rate rise reduces the market price and changes nothing you receive. The coupons and the face value are fixed by contract, so the opening gap on the screen is irrelevant to a holder who is not selling.
Which is why there is no stop and no need for one. A stop would convert a matched liability into a market position, which is the opposite of the intention.
Selling early breaks the structure and pays the spread. A dealer quotes a gap between the price it buys at and the price it sells at, and in a thin issue that gap can be wide enough to cost several coupons.
Setting one up
Start from the liability, not the yield. Name the amount and the date. Everything else is arithmetic in service of those two numbers.
Then choose issuers you are willing to be owed by for the whole term. The yield on offer is compensation for credit risk, and reaching for extra yield in a structure whose only real risk is credit is exactly the wrong trade. A bullet built from risky issuers has taken the one risk the design cannot handle in exchange for the return the design was not trying to maximize.
And leave a margin. Sizing the bullet to exactly the obligation assumes no default, no fee and no change in the amount needed. A little more than required is the whole contingency plan.
What a bullet strategy is not
It is not a return strategy. It matches a liability.
It is not a ladder. A ladder spreads the dates.
It is not free of credit risk. That one remains.
And it is not harmed by rate moves. Only by selling early.
How this connects
The yield to maturity at purchase is the return the structure locks in, provided every bond is held to its date and the issuer pays.
A zero coupon bond is the purest bullet. It pays nothing until maturity, so there are no coupons to reinvest along the way and the sum on the date is known exactly.
A callable bond undermines the design, because the issuer can repay early and hand the money back years before the date it was bought for.
Near dates can be met with treasury bills or a certificate of deposit with a matching term, which do the same job with less to research than individual bonds.
Bond duration measures how far a price moves when rates change, and a holder who never sells only ever experiences that movement on paper.
A target-date fund is not the same thing, even though both are named for a date: a fund keeps rolling its bonds and never matures, so the value on the date is not fixed.
A corporate bond pays more than a government issue of the same date, and that extra is compensation for the one risk the structure cannot remove.
And the yield curve sets what a bullet costs to build, since its shape decides how much a distant date pays compared with a near one.
When it fails
In a flat market it works precisely as specified, which is worth stating because it makes the approach look dull next to anything else on this site. Doing exactly what was promised is the product.
The second failure is needing the money early. The structure assumes the date, and selling before it gives up both the certainty and the spread.
A third is reaching for yield. Credit risk is the one exposure the design cannot neutralize.
A fourth is ignoring inflation. The nominal amount is fixed, and what it buys on the date is not.
A fifth is buying all the bonds at one moment. That concentrates the entry yield as well as the exit.
And a sixth is sizing it to the exact obligation. No margin means no room for anything at all.
The original data
Of the 24,971 videos in the finance search study this site keeps, 12 have “bond” or “bonds” in the title, at a median of 61,898 views across 12 channels. “Treasury” appears in 6 at a median of 9,776. No video is counted twice, however many searches surfaced it.
The question: Rates rose and the bonds are down. Sell?
Twelve videos at a median of 61,898 views. The largest market in the world is covered twelve times in nearly twenty-five thousand videos, and half of those found an audience above fifty thousand. Structures like this one — plain, mechanical, genuinely useful to somebody with a date and an amount — are simply not being made.
The answer to that final question is no, and the reason is the structure rather than a view on rates. A held-to-maturity bond pays its face value whatever the screen says in between. Selling converts a matched liability into a realized loss — the only circumstance in which the price drop becomes real is the one where you act on it.
Related
Treasury futures is where the same instruments are traded rather than held. Default is the single risk this structure cannot design away. And portfolio building is where a matched liability sits alongside everything else you own.
The bullet reframes the bond question. Asking what a bond will return is a market question; the bullet asks something else: you need a specific amount on a specific date, so what do you buy today to make sure it is there? Once the question is a liability rather than a return, most of the price movement in between stops being interesting.
— Michael Whitman
This page is educational, not financial advice. Test every idea on your own charts before risking money.