1/ Bonds & Yields 102
This week, I posted a thread laying out the basics of bonds and yields - Bonds & Yields 101.
I got a lot of questions on more advanced topics - yield to maturity, negative yields - so I'll continue with the series.
Here's Bonds & Yields 102!
This week, I posted a thread laying out the basics of bonds and yields - Bonds & Yields 101.
I got a lot of questions on more advanced topics - yield to maturity, negative yields - so I'll continue with the series.
Here's Bonds & Yields 102!
2/ First off, make sure you follow the basics. Check out my thread - Bonds & Yields 101 - to get a quick primer on the topic.
3/ Let's talk about Yield to Maturity.
In Bonds & Yields 101, we covered the concept of Yield in its most basic form: Current Yield.
Current Yield is just the return an investor would earn if she purchased a bond and held it for a year.
Current Yield = Annual Coupon / Price
In Bonds & Yields 101, we covered the concept of Yield in its most basic form: Current Yield.
Current Yield is just the return an investor would earn if she purchased a bond and held it for a year.
Current Yield = Annual Coupon / Price
4/ Yield to Maturity ("YTM") is the annual return an investor would earn if she purchased a bond and held it until maturity (when the principal is paid back in full).
At issuance, the Current Yield and Yield to Maturity are equal, but they deviate over time.
At issuance, the Current Yield and Yield to Maturity are equal, but they deviate over time.
5/ An example:
Say you buy a Hertz bond (don't do this!) that matures in 1 year and has a 10% coupon rate and a $1,000 par value. You pay $800 for the bond.
Current Yield = $100 / $800 = 12.5%
YTM = (Interest+Principal) / Price - 1
YTM = ($100+$1000) / $800 - 1
YTM = 37.5%
Say you buy a Hertz bond (don't do this!) that matures in 1 year and has a 10% coupon rate and a $1,000 par value. You pay $800 for the bond.
Current Yield = $100 / $800 = 12.5%
YTM = (Interest+Principal) / Price - 1
YTM = ($100+$1000) / $800 - 1
YTM = 37.5%
6/ Note that the equation becomes more complicated when looking at longer maturities, as you have to discount the future cash flows. We can save that for another thread!
Now that we have the basics down, let's take a look at a very relevant (and weird) topic: negative yields.
Now that we have the basics down, let's take a look at a very relevant (and weird) topic: negative yields.
7/ How do negative yields work? Let's slightly modify our example to illustrate.
You buy a US Treasury bond (safe!) that matures in 1 year and has a 1% coupon rate and a $1,000 par value. You pay $1,100 for the bond.
YTM = ($10+$1000) / $1,100 - 1
YTM = -8.2%
Negative yield!
You buy a US Treasury bond (safe!) that matures in 1 year and has a 1% coupon rate and a $1,000 par value. You pay $1,100 for the bond.
YTM = ($10+$1000) / $1,100 - 1
YTM = -8.2%
Negative yield!
8/ So negative yields arise when an investor is receiving less money by holding the bond than they paid to purchase it.
An investor is PAYING for the right to loan money - weird!
Why might this happen?
▪️ Flight to safety
▪️ Central Bank "yield curve control"
▪️ Deflation risk
An investor is PAYING for the right to loan money - weird!
Why might this happen?
▪️ Flight to safety
▪️ Central Bank "yield curve control"
▪️ Deflation risk
9/ We will see more of this globally in the years to come (hint: buy gold!).
While far from comprehensive, I hope this was a helpful primer on the concept of Yield to Maturity and how negative yields may arise in this environment.
Stay tuned for more in this series...
While far from comprehensive, I hope this was a helpful primer on the concept of Yield to Maturity and how negative yields may arise in this environment.
Stay tuned for more in this series...
