What does negative bond yield mean?

by Manshu on July 9, 2012

in Investments

In India, we have very high rates of interest and while we are quite familiar with negative real rate of interest, we don’t often come across negative bond yields.

Negative real rate of interest is when your nominal interest doesn’t cover inflation, but a negative bond yield means that the returns you get from the bond are negative even in nominal terms.

This recently happened for a brief while with some German bonds, and Dhruv posted the following comment in the Suggest a Topic section.

Dhruv July 7, 2012 at 5:04 pm

Recently I read a news about German 2 year note yields fell to record lows of minus 0.01 percent , what does this actually mean(the minus sign on bond yields)?

This situation with the negative yields gives a good opportunity to not only look at negative bond yields but briefly touch upon Zero Coupon Bonds as well.

Zero Coupon Bonds are bonds that don’t have an interest rate, and don’t make any periodic payments at all. Investors buy these bonds because they are sold at a discount and redeemed at face value, and that’s how investors make their money. So, a bond of face value Rs. 100 may be auctioned at Rs. 95 and then when it is redeemed at Rs. 100, the investor makes the 5 rupee difference. This is a good link that explains the Zero Coupon Bonds in brief and also has a calculator to calculate yield on such bonds.

Germany issued such bonds with a two year maturity last month called Schatz, and they were sold at 99.87 Euros for a 100 Euro Face Value bond. So that’s just a very small yield of 0.07% to begin with.

Then about a week after the issue when the bond began trading in the market, the yield turned negative, which means that the bond traded for more than 100 Euros for a short while. This happened again last week when the yield on the Schatz turned negative due to Euro area concerns.

This example is for zero coupon bonds, but the yield can turn negative even for interest bearing bonds if they trade in the market and if their price is greater than the face value plus the interest payments that are remaining on the bonds.

Low or negative yields indicate that investors are seeking a very high degree of safety for their money, and for this reason this kind of thing is only seen in the bonds of developed countries, and that too occasionally. It is highly unlikely that we will ever witness this situation in India.

This post is from the Suggest a Topic page.

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{ 14 comments… read them below or add one }

PP July 9, 2012 at 11:18 am

“Then about a week after the issue when the bond began trading in the market, the yield turned negative, which means that the bond traded for more than 100 Euros for a short while.”

Maybe I’m missing something here, but if the face value of these bonds is 100 Euros why would someone want to buy those for more than 100 Euros and make a loss, even if marginal?

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Manshu July 9, 2012 at 3:20 pm

For safety of money. If you are a large investor with millions of dollars to park then as far as ultra safe investments are concerned, you’re options are narrowed down quite a bit. So these people are looking for safety of money.

The yield is negative even today.

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ankurm July 9, 2012 at 4:20 pm

Does it imply expectation of deflation?

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Manshu July 9, 2012 at 5:29 pm

In this instance, more like expectation of a Euro breakup.

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ankurm July 9, 2012 at 4:32 pm

Read somewhere that even yields on Danish and Swiss two-year government bond are negative. The more steep the yield in negative territory, the stronger the economy?

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Manshu July 9, 2012 at 5:29 pm

I’m sure it does, yeah.

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ankurm July 9, 2012 at 6:10 pm

This negative yield seems to be a temporary anomaly, isnt it?. Rather than loosing money on German bond investment, someone would prefer to keep the money with himself (withdraw and keep under mattress even if bank in which saving account is going bust!!)

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Manshu July 9, 2012 at 7:42 pm

I wonder how many mattresses it will take to stuff a few hundred million Euros.

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ankurm July 9, 2012 at 8:07 pm

Hehehe…Are you assuming that the entire system is going bust and then people will start running for mattresses? By that withdrawal action itself banking system will go bust!!!
Otherwise you could hold on to your bank accounts for convenience sake atleast.

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Krunal July 27, 2012 at 3:37 pm

Euro Zone crisis = negative yield on bonds…

then increase in yield (say from 4% to 6%) = risky and high cost of borrowing..?? is it….wic will again lead to credit crisis situation…
please comment….

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Manshu July 29, 2012 at 1:26 am

This is not a simple equation like that…

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Krunal July 27, 2012 at 3:46 pm

and also… negative yield = looking for safety of money…
then can v see money flowing to developing countries like india china….

please comment….

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Manshu July 29, 2012 at 1:25 am

No global investor equates India with safety, so that’s not going to happen.

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Kevin November 8, 2012 at 2:32 am

Good article, Manshu. I am still recommending negative yielding TIP Bonds to clients. I believe the inflation protection is well worth living with the negative yield. US debt will soon reach the tipping point and I believe inflation will spike considerably.

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