Welcome to Finance and Fury, The Say What Wednesday Edition

This week Question from Mark – two-part episode (over this week and next)

Hi Louis

I have 2 questions, can you explain how negative yielding bonds work, they are saying a third of the global bond market is in negative yielding debt and it is going parabolic.

How do people make money from negative yielding debt? It doesn’t make sense.

Also, can you explain the repo markets that are going on at the moment?

Apparently the banks are loaning money from the Feds at 10% so they have enough liquidity to survive the night # Bank run?

 

How can a bond have a negative yield?

  1. Negative-yielding bonds are bonds that cause bondholders to lose money when they mature. This happens when holders of such bonds will end up with less money than what they used to purchase them
  2. Negative Yield works through the mechanics of bonds – when the prices go up to where the yield is close to zero – and they are based in a nominal real value $100 – in 10 years’ time inflation eats away at the value

 

First – Explanation of Fixed Interest (bonds) –  terminology –

  1. You don’t get interest payments – you get coupons = The periodic interest payments promised to bond holders are computed as a fixed percentage of the bond’s face value; this percentage is known as the coupon rate.
  2. The face value (also known as the par value) of a bond is the price at which the bond is sold to investors when first issued; it is also the price at which the bond is redeemed at maturity.  In the U.S., the face value is usually $1,000 – Face Value is the amount of money you get back in at maturity of the bond
  3. Note that the face value is not the price – the price is what someone wants to pay for a bond
  4. You cannot receive any coupons and the yield on the bond may be positive – if the nominal value of the bond will rise to give you a return – or yield
  5. The maturity is the date at which you get your money back – Bonds are debt instruments – but what they really function as is a way of borrowing funds – funding projects/capital requirements for banks through selling a newly created asset and selling it to investors – in exchange for money – it is a loan that is in the form of an investment which can be traded –

 

In Current Markets

– A yield decline will start to occur if investors are buying a bond for more than its face value

  1. How do Negative-Yielding Bonds Work? – To understand negative-yielding bonds, let’s first examine how regular bonds work to see how money can be lost on them at maturity – then how it differs from bonds that lose money.
    1. Two main categories for regular bonds: coupon and non-coupon paying bonds
    2. Normally – an investor should ordinarily end up with more than what they paid for the bond
      1. If there is no income (coupons) – price of bond should be at a large discount to maturity FV
      2. I.e. – Bond matures in 3 years for $100 – buy today at $90 – YTM = 3.5% p.a. even without coupons
  2. Very simple to calculate the Price of a Bond – literally a formula to get the exact price based around a few variables – A bonds price is that of the present value of all coupon payments plus the face value paid at maturity.

  1. F = face value, C = coupon payment, N = number of payments, i = market interest rate, or required yield, M = value at maturity, usually equals F
  2. This formula shows that the price of a bond is the present value of its promised cash flows.  As an example, suppose that a bond has a face value of $1,000, a coupon rate of 4% and a maturity of 30 years.  The bond makes annual coupon payments every year – 30 payments –  If the interest rate is 4%
    1. Price = $1000 = same as FV – interest rates and coupons same – so no discount in price or premium of price
    2. What happens if the interest rate drops? Same bond – but interest rates now drop to -1% – price is now $2,760 – paying
    3. Each year the investor receives $40 in coupon payments and when the bond matures, they receive $1000 at maturity – though the investor paid more – yearly coupon payments made up for the difference of holding in cash with negative interest rates –
  3. But now let’s say that the same bond sold for the same amount – but wasn’t paying coupons? They get a negative yield (return) on their bond
  4. Prices and Yield to maturity – Can lead to negative yields – another simple example –
    1. Maturity: 3 years, FV: $1,000, Coupon: 0% Price: $1,050
    2. During the three years, you get no income payments and when the bond matures you only get $1,000 back –
    3. Loss of $50 over the 3 years works out to be about a negative yield of 1.6%
  5. Therefore – If the total amount of income the bond pays over its remaining lifetime is less than the premium the investor paid for the bond, the investor loses money and the bond is considered to have a negative yield.
  6. With QE going on 10 years now – there are a lot of bonds being purchased in the secondary market – demand for bonds is high – the price can go up

State of bonds: Who Issues and Buys Negative-Yielding Bonds?

  1. Negative-yielding debt is not new in Europe and Japan – issued by governments  
    1. Japan – the interest rate set is below 0% – so with negative interest rate the central bank charges banks for keeping deposits – which is passed on to consumers –
      1. Monetary policy that tries to encourage banks to lend out money and stimulate the economy
    2. The same strategy has been used by the European Central Bank.
  2. Therefore – As countries put in negative interest rates – government bonds are created that have negative yields – or below zero returns –
    1. Why would anyone buy them? Banks still purchase these bonds as they have good liquidity and there are a few options safer than a government bond.
    2. Also – the more fixed-income securities become negative-yielding, the yields offered by bonds will continue to enter the negative territory – so investors buy bonds with negative yields because they believe future bonds will offer even worse returns – speculation to buy now to not get charged negative interest rates and to not lose more money in future if newly created bonds have worse returns

Number of bonds with negative yields are starting to reduce

  1. The stock of Euro-zone government bonds with a negative yield on Tradeweb ballooned to around 5.61 trillion euros ($6.2 trln), or almost 69% of the total market, in August. It has since eased to around 5 trillion euros or 62%, according to data from the electronic trading platform.
  2. Globally, the pile of negative-yield bonds including corporate debt has shrunk to around $12.5 trillion from a record high around $17 trillion just two months ago.
  3. Indeed, this week France’s 10-year bond yield turned positive for the first time since July FR10YT=RR and the entire yield curve in Germany — the euro zone’s benchmark issuer — is no longer negative as it was a month ago.
  4. But for many bond investors, it is still early days.

 

Part 2 of the question – Repo markets – A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of short-term borrowing, mainly in government securities. The dealer sells the underlying security to investors and buys them back shortly afterwards, usually the following day, at a slightly higher price – This is a pretty heavy topic – lots of parts to unpack – so part 2 will be next week

Thanks for listening to today’s episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact/

Why do we look to be in a Property Bubble?

Welcome to Finance and Fury, the Furious Friday edition. Today we have a pretty good episode! (I find this interesting at least, so I hope you do too) – We’re talking about the Australia Property market, specifically the property bubble. How monetary policy has...

Say What Wednesday: How to negotiate with real estate agents

Welcome to Say What Wednesday! Today’s question is from Mark; “Hi guys, lovin’ the show – I’m looking to buy my first place in Brisbane and I was just wondering if you have any tips on how to negotiate with the real estate agents and work out what price I should be...

Commercial v Residential Property; the pros and cons if you’re considering investing

Episode 23 Commercial v Residential Property; the pros and cons if you're considering investing Welcome to Finance and Fury In today’s episode we’re talking about property - Commercial vs Residential. It’s often a question people ask when they’re looking to start...

Build to rent: Why are Banks and Super Funds becoming large Corporate Landlords?

Welcome to Finance and Fury,  Past few Monday eps on Share concentration – and the holdings and influence that super funds have Today – talk about the legislation put into place and the plans going on now where you might end up renting an apartment from your super...

Say What Wednesdays: Where to start when you don’t know where to start; financial literacy in an age of information overload

Say What Wednesdays Where to start when you don't know where to start; financial literacy in an age of information overload Welcome to Say What Wednesday - Today’s episode is a special one! Plus there’s a bit of an announcement at the end. This all started with a...

Accumulating wealth and the steps to take in preparing for Financial Independence and funding retirement expenses

Welcome to Finance and Fury, the Say What Wednesday Edition Today's episode is about building wealth and getting ready for retirement Keeping with the Theme – Solving the economic problems Using the resources you have (income, savings, equity, etc.) to get what you...

Can shares be leveraged as part of a property purchase?

Welcome to Finance and Fury, The Say What Wednesday Edition I would like to start by saying a big thank you for the knowledge you have passed onto myself and the community. My question lies around equity, if you have a considerable amount of money in shares, say 200k,...

What does a good asset allocation for passive income look like?

Welcome to Finance and Fury, The Say What Wednesday Edition.  Where each week we answer a question from you. Hi Louis, I have a questions about portfolio construction and asset allocation. I am 36 years old and am trying to understand what is the most appropriate...

Leveraging: how the wealthy get wealthy, how the rich get rich!

Episode 7 Leveraging: how the wealthy get wealthy, how the rich get rich! This is how the wealthy get wealthy, how the rich get rich! We’re discussing the two-tiered economy and leveraging – taking something that you don’t have, investing it, and growing that over...

Furious Fridays: Evil Capitalism!!! Efficiencies, incentives, equal opportunities and reducing poverty

Furious Friday Evil Capitalism!!! Efficiencies, incentives, equal opportunities and reducing poverty Welcome to Furious Fridays Imagine you are a child in Korea.... North Korea - After school (which is mostly propaganda to solidify your ruler), 10 years mandatory...

Pin It on Pinterest

Share This