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OPINION

Better a bond in the hand

Better a bond in the hand
June 23, 2017
Better a bond in the hand

Deciding whether to buy a bond, if at all, involves guesstimating a series of issues as they are now and whether they will remain thus over the life of the paper. The quality of the name of the issuer - ie: how likely are you to get your capital back - is all-important with AAA rated sovereign debt at the top of the pecking order. Rating agencies make most of their money doing this.

How long you have to wait to get your money back, known as maturity, is another factor to consider. Generally the longer you are willing to lend out your dosh, the higher the interest earned. Terminology is flexible and varies between countries but usually anything with less than two years' tenure is known as a bill, between two and 10 years is called a note, and anything longer a bond. Only good names can borrow ultra-long term, the US Treasury preferring to keep a lid at 30 years, UK Treasury currently has 16 different issues with maturities over 30 years (longest until 2068), and Japan focusing in the 10-year area but some expiring in 2047.  

 

 

Very occasionally a company issues debt maturing in a century. You can imagine how someone trying to run a business would love to have locked in funding requirements for this long. Miracles can and do happen such as Monday's new issue of 100-year sovereign debt by serial-defaulter the Republic of Argentina. Rarity value meant the US dollar-denominated bond yielded less than 8 per cent when issued.

Bond interest is fixed when the paper is first sold and remains constant throughout, coupons paid six monthly. Deciding at what level to pitch the coupon will depend on the current level of interest rates in that currency, what other similar issuers' bonds are yielding, and if for some reason there is a shortage or glut of this type of paper. Investment banks, brokers, and end users have vast teams monitoring popular issues, buying and selling as required to maximise profit or adjust to new needs. Boutiques often specialise in more exotic and unusual issues while 'plain vanilla' paper is today mainly traded on computer matching systems.

Absolute levels of interest will change and therefore the price of existing bonds varies, supply and demand in full force with bonds value rising as interest rates drop. The yield curve is the current interest rate for all maturities, yields plotted on the Y axis and maturities going out in time along the X axis. Changes in the shape of this line denote current preferences, whether the market is stressed, and reflects forecasts as to what might happen next. They are known as bond vigilantes for good reason.

 

US 10-year Treasury

 

 

 

UK 10-year gilt

 

 

 

German 10-year Bund

 

 

 

Japan 10-year bond