What is a 'Benchmark Bond'

A benchmark bond is a bond that provides a standard against which the performance of other bonds can be measured. Government bonds are almost always used as benchmark bonds.

A benchmark bond is also referred to as a benchmark issue or bellwether issue.

BREAKING DOWN 'Benchmark Bond'

A benchmark equity, like the S&P 500 or Dow Jones Industrial Average (DJIA), is used to track the performance of company stocks trading on the markets. Stock investors can run a comparison of a company’s shares with a similar equity in the benchmark to understand what level the company’s shares are performing at. The concept of a benchmark bond is similar to a benchmark equity, but a benchmark bond works in a slightly different way.

Essentially, the benchmark bond is a security which the prices of other bonds react to. Bond investors and fund managers use the benchmark bond as a yardstick for measuring bond performance and to understand what rate of return to demand in excess of the benchmark return. For a comparison to be appropriate and useful, the benchmark and the bond being measured against it should have a comparable liquidity, issue size, and coupon. For example, the 10-year US Treasury bond is mostly used as a benchmark for 10-year bonds in the market. Because Treasury securities are considered to be riskless investments guaranteed by the full faith and credit of the US government, these securities offer a risk-free return. An investor that wants to gauge the return for a 10-year corporate bond, which most likely has more risk than a government bond, will compare the yield to the 10-year Treasury bond. If the yield on a 10-year T-bond is going for 2.85%, the investor will demand a risk premium in excess of 2.85% from the corporate bond issuers.

More specifically, the benchmark bond is the latest issue within a given maturity. While the decision regarding what equity to include as a benchmark is made by a committee following broad rules about the operations of the companies represented by a benchmark index, including a benchmark bond or replacing one benchmark bond with another is determined by the characteristics of the bond. Characteristics include maturity date, credit rating, issue size, and liquidity. A bond that meets the stated criteria is included as a benchmark. In addition, on the rebalance date, which could change the bond index constituents, bonds no longer meeting the index criteria will be removed, and any new bonds that do meet the criteria will be added.

For example, the Treasury issues and re-issues 5-year bonds, used as a benchmark bond for 5-year bonds, on a frequent basis. As months and years go by, the 5-year bond maturity date reduces to 4.5, 4, 3.8, 3.7, 3 years, and so on, until it reaches its maturity date. However, in a normal interest rate environment, bond yields go down as the bond approaches maturity. In effect, longer-term bonds have higher yields than shorter-term bonds. Therefore, a benchmark that approaches maturity will be valued at successively lower yields. To bring the yield back up, the government will issue another 5-year bond. This latest issue will replace the older issue as the benchmark bond for 5-year bonds.

RELATED TERMS
  1. Bond Fund

    A bond fund is a fund invested primarily in bonds and other debt ...
  2. Bond

    A bond is a fixed income investment in which an investor loans ...
  3. Bond ETF

    Bond ETFs are very much like bond mutual funds in that they hold ...
  4. Bond Buyer 11

    The Bond Buyer 11 (BB11) index is a theoretical and estimated ...
  5. Extendable Bond

    An extendable bond (or extendible bond) is a long-term debt security ...
  6. Bond Ladder

    A bond ladder is a portfolio of fixed-income securities in which ...
Related Articles
  1. Investing

    Corporate Bond Basics: Learn to Invest

    Understand the basics of corporate bonds to increase your chances of positive returns.
  2. Investing

    Find the Right Bond at the Right Time

    Learn about the types of bonds you should consider investing in, when you should be buying them and how to compare yields against their time to maturity.
  3. Investing

    5 Fixed Income Plays After the Fed Rate Increase

    Learn about various ways that you can adjust a fixed income investment portfolio to mitigate the potential negative effect of rising interest rates.
  4. Investing

    The Basics Of Bonds

    Bonds play an important part in your portfolio as you age; learning about them makes good financial sense.
  5. Investing

    The Best Bet for Retirement Income: Bonds or Bond Funds?

    Retirees seeking income from their investments typically look into bonds. Here's a look at the types of bonds, bond funds and their pros and cons.
  6. Investing

    Using U.S. Savings Bonds As a Long-term Investment

    A 20-year Series EE savings bond pays more interest than a 20-year Treasury bond. Government-issued long-term bonds might not always be the best choice.
  7. Investing

    How Bonds Are Vital to a Successful Portfolio

    While bonds are a vital part of an investment portfolio, they are often ignored.
  8. Investing

    4 basic things to know about bonds

    Learn the basic lingo of bonds to unveil familiar market dynamics and open to the door to becoming a competent bond investor.
RELATED FAQS
  1. What causes a bond's price to rise?

    Should you invest into bonds? Learn about factors that influence the price of a bond, such as interest rates, credit ratings, ... Read Answer >>
  2. What are the risks of investing in a bond?

    Are you thinking of investing in bond market? Learn more about bond market investment risk, including interest rate risk, ... Read Answer >>
Trading Center