NEGATIVE YIELD BONDS
CONTEXT:
- Recently, China sold negative-yield debt for the first time, and this saw a high demand from investors across Europe. As yields in Europe are even lower, there was a huge demand for the 4-billion-euro bonds issued by China.
MORE ABOUT NEGATIVE YIELD BONDS
- Negative-yield bonds are debt instruments that offer to pay the investor a maturity amount lower than the purchase price of the bond. These are generally issued by central banks or governments, and investors pay interest to the borrower to keep their money with them.
BOND: Is an instrument to borrow money. A bond could be floated/issued by a country’s government or by a company to raise funds.
YIELD: The yield of a bond is the effective rate of return that it earns. But the rate of return is not fixed; it changes with the price of the bond.
- Generally, investors purchase the bonds at their face value, which is the principal amount invested. In return, investors typically earn a yield of a bond.
- Each bond has a maturity date, which is when the investor gets paid back the principal amount.
REASONS FOR HIGH DEMAND TO NEGATIVE YIELD BOND
- Pandemic: Negative-yield bonds attract investments during times of stress and uncertainty as investors look to protect their capital from significant erosion.
- Much lower yield in Europe: The fact that the 10-year and 15-year bonds are offering positive returns is a big attraction at a time when interest rates in Europe have dropped significantly.
- China’s Economic Growth – It is important to note that while the majority of the large economies are facing a contraction in their GDP for 2020-21, China is one country that
- is set to witness positive growth in these challenging times: its GDP expanded by 4.9% in the third quarter of 2020.
- Chinese control Over Pandemic – While Europe, the US and other parts of the world are facing a second wave of Covid-19 cases, China has demonstrated that it has controlled the spread of the pandemic and is therefore seen as a more stable region.
- Availability of money: Huge amount of liquidity injected by the global central banks after the pandemic. Investors could also be temporarily parking money in negative-yielding government debt for the purpose of hedging their risk portfolio in equities.
- To take Benefit from Currency Gain: Foreign investors might believe the currency’s exchange rate will rise, which would offset the negative bond yield.
- To Avoid Domestic Deflation Risk: Domestically, investors might expect a period of deflation, or lower prices in the economy.
o For Example: Consider a one-year bond that yields minus 5% but at the same time inflation is expected to be minus 10% over the same period.
o That means the investor in the bond would have more purchasing power at the end of the year because prices for goods and services would have declined far more than would the value of the investment in the fixed-income security.