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negative yielding bonds

Question from someone without a finance background -

1. Why does someone buy a negative yielding bond ?  Is it a bet that interest rates are going to go more NEGATIVE in the future?

2.  In a low interest rate environment (+1 to -1%) , does one's asset allocation need to be altered to still maintain stability of a portfolio...e.g more cash, less bonds ?

If you own a German 10 year Bund (currently yielding a negative interest rate), you are currently paying interest for the right to lend Euros to the German Government.

If they leave the EU and go back on the Deutsche Mark, they have to now pay you that same number of Euros but in Deutsche Marks.   Let’s say it was a note worth 1 million euros so now it is 1 million Deutsche Marks.

Someone else lent Greece 1 million Euros, and they are currently earning a positive interest rate.   They now have an asset that is payable by the Greek Government in the form of 1 million Drachma.

You Win.   They Lose.   You just realized a massive gain in real terms.   They just realized a massive loss of purchasing power in real terms.

By buying a Greek bond and selling a German bond right now, you can earn a substantial positive carry.   You are essentially collecting “theta” to be short vol on the EU imploding.

If you bet this the other way, you are paying time decay for the possibility to make a windfall when the EU dissolves.

 

 

 

 

 

Hi Mehul,

There many reasons you might buy a negative yielding bond:

1) The currency fluctuations might actually make it a positive yielding bond.

2) The yields could go even more negative in which case this very convex bond appreciates quite a lot.

3) You believe inflation will remain low and so a negative yield is a relatively good safe asset to hold.

4) You are financing the negative bond at an even more favorable rate.

As for investing in bonds when rates are low - I think people just need to accept the reality that being more active in your bond portfolios is a necessity. The potential for rising interest rate risk needs to be managed. After all, you can't just sit in cash if rates rise. You need a better hedge because you're getting whacked by inflation AND low yielding bonds in that case. So you want some sort of strategy that can invest in potentially higher yielding bonds AND also try to reduce your interest rate risk.

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