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.
DhruvÂ 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.