Negative Bond Yield

What Is a Negative Bond Yield?

A negative bond yield is the point at which an investor receives less money at the bond's maturity than the original purchase price for the bond. A negative bond yield is an unusual situation wherein issuers of debt are paid to borrow.

At the end of the day, the contributors, or buyers of bonds, are really paying the bond issuer a net amount at maturity as opposed to earning a return through interest income.

Understanding Negative Bond Yields

Bonds are debt instruments normally issued by corporations and governments to fund-raise. Investors purchase the bonds at their face value, which is the principal amount invested.

In return, investors ordinarily get compensated an interest rate — called the coupon rate — for holding the bond. Each bond has a maturity date, which is the point at which the investor gets compensated back the principal amount that was initially invested or the face value of the bond.

Bond Value

Bonds that have been recently issued and sold by investors before the maturity trade on the secondary market called the bond market. Bond prices rise and fall contingent upon different economic and monetary conditions in an economy.

The initial price of a bond is generally its face value, which could be $100 or $1,000 per bond. In any case, the bond market could price the bond contrastingly contingent upon a number of factors, which could incorporate economic conditions, the supply and demand for bonds, the time span until expiration, and the credit quality of the responsible entity. Accordingly, an investor probably won't receive the face value of the bond when they sell it.

Normally, an investor could buy a bond at a $95, for instance, and receive the $100 face value at maturity. All in all, the investor would've bought the bond at a discount ($95) to the face value ($100). Negative yielding bonds would bring about an investor getting less back at maturity, meaning an investor could pay $102 for the bond and get back $100 at maturity. Notwithstanding, the coupon rate or interest rate paid by the bond additionally plays into whether the bond is negative-yielding.

Bond Yield

Bonds trading in the open market can successfully carry a negative bond yield on the off chance that the price of the bond trades at an adequate premium. Recollect that a bond's price moves inversely with its yield or interest rate; the higher the price of a bond, the lower the yield.

The justification behind the inverse relationship among price and yield is due, in part, to bonds being fixed-rate investments. Investors could sell their bonds assuming it's expected that interest rates will rise before long and opt for the higher-rate bonds later on.

On the other hand, bond investors could buy bonds, driving the prices higher, on the off chance that they accept interest rates will fall in the future on the grounds that existing fixed-rate bonds will have a higher rate or yield. At the end of the day, when bond prices are rising, investors expect lower rates in the market, which increases demand for beforehand issued fixed-rate bonds as a result of their higher yields. Sooner or later, the price of a bond can increase adequately to infer a negative yield for the purchaser.

Why Investors Buy Negative Yielding Bonds

Investors that are interested in buying negative-yielding bonds incorporate central banks, insurance companies, and pension funds, as well as retail investors. Notwithstanding, there are different distinct purposes behind the purchase of negative-yielding bonds.

Asset Allocation and Pledged Assets

Numerous hedge funds and investment firms that oversee mutual funds must meet certain requirements, including asset allocation. Asset allocation means that the investments inside the fund must have a portion allocated to bonds to assist with making a different portfolio.

Distributing a portion of a portfolio to bonds is intended to reduce or hedge the risk of loss from different investments, like equities. Subsequently, these funds must possess bonds, even on the off chance that the financial return is negative.

Bonds are in many cases used to pledge as collateral for financing and subsequently, should be held no matter what their price or yield.

Currency Gain and Deflation Risk

A few investors accept they can in any case bring in money even with negative yields. For instance, foreign investors could accept the currency's exchange rate will rise, which would offset the negative bond yield.

At the end of the day, a foreign investor would switch their investment over completely to a country's currency while buying the government bond and convert the currency back to the investor's neighborhood currency while selling the bond. The investor would have a gain or loss simply from the currency exchange variance, independent of the yield and price of the bond investment.

Locally, investors could expect a period of deflation, or lower prices in the economy, which would permit them to bring in money by utilizing their savings to buy more goods and services.

Safe Haven Assets

Investors could likewise be interested in negative bond yields on the off chance that the loss is short of what it would accompany another investment. In times of economic uncertainty, numerous investors race to buy bonds since they're considered safe-haven investments. These purchases are called the flight-to-safety-trade in the bond market.

During such a period, investors could acknowledge a negative-yielding bond on the grounds that the negative yield may be definitely to a lesser extent a loss than a potential twofold digit percentage loss in the equity markets. For instance, Japanese Government Bonds (JGB) are well known safe-haven assets for international investors and have, on occasion, paid a negative yield.

Illustration of a Negative Bond Yield

The following is an illustration of two bonds, one of which procures income while the other is negative-yielding when of the bond's maturity.

Bond ABC has the accompanying financial qualities:

• Maturity date of four years
• Face value of $100
• Coupon interest rate of 5%
• Bond price for $105

Bond ABC was purchased for a premium, meaning the price of $105 was higher than its face value of $100 to be paid at maturity. At the beginning, the bond may be viewed as negative-yielding or a loss for the investor. In any case, we must incorporate the bond's coupon rate of 5% each year or $5 to the investor.

Thus, albeit the investor paid an extra $5 for the bond initially, the $20 in coupon payments ($5 each year for quite a long time) make a $15 net profit or a positive yield.

Bond XYZ has the accompanying financial characteristics:

• Maturity date of four years
• Face value of $100
• Coupon interest rate of 0%
• Bond price for $106

Bond XYZ was likewise purchased for a premium, meaning the price of $106 was higher than its face value of $100 to be paid at maturity. In any case, the bond's coupon rate of 0% each year makes the bond negative-yielding. All in all, assuming investors hold the bond until maturity, they'll lose $6 ($106-$100).

The $6 loss means a 6% loss in percentage terms, and when spread out over the four years, it likens to a negative-yield of - 1.5% (- 6%/4 years) every year.

Features

• Negative-yielding bonds are purchased as safe-haven assets in times of disturbance and by pension and hedge fund managers for asset allocation.
• Even while figuring in the coupon rate or interest rate paid by the bond, a negative-yielding bond means the investor lost money at maturity.
• A negative bond yield is the point at which an investor receives less money at the bond's maturity than the original purchase price for the bond.