Negative-Yielding Bonds

Bonds that cause bondholders to lose money when it matures

What are Negative-Yielding Bonds?

Negative-yielding bonds are bonds that cause bondholders to lose money when they mature. This happens when holders of such bonds will end up with less money than what they used to purchase them. In 2019, the amount of negative-yielding bonds in the global market is $13 trillion.

 

Negative-Yielding Bonds

 

Quick Summary Points

  • Negative-yielding bonds are financial instruments that cause purchasers to lose money.
  • They are usually issued by governments in countries with low or negative interest rates and bought by investors who want to keep money safe or avoid worse yields.
  • Sub-zero debt is growing and corporate issuers are starting to issue bonds with negative yields as well.

 

How do Negative-Yielding Bonds Work?

To understand negative-yielding bonds, let’s first examine how regular bonds work and then how it differs from bonds that lose money. There are two main categories for regular bonds: one that has coupons and one that does not. Either way, an investor should ordinarily end up with more than what they paid for the bond.

1. For example, look at a bond with the following characteristics:

  • Maturity: 3 years
  • Par Value: $100
  • Coupon: 0%
  • Price: $90

During the three years, they receive no coupon payment. However, when they bond matures, they receive $100. This is a YTM of 3.5%.

 

2. Let’s look at another example:

  • Maturity: 3 years
  • Par value: $100
  • Coupon: 5%
  • Price: $105

Each year the investor receives $5 in coupon payments and when the bond matures, they receive $100 in par payment. Even though the investor paid more than the par value, the yearly coupon payments made up for the difference.

 

3. With negative-yielding bonds, investors won’t receive enough in coupons or par value payments to make up for the cost of the bond. For example, take a look at this bond:

  • Maturity: 3 years
  • Par value: $100
  • Coupon: 0%
  • Price: $105

During the three years in which the investor is holding onto the bond, they will not receive any interest payments. When the bond matures, the investor will only receive $100 even though they paid $105 for it. This leads to a negative yield of 1.6%.

 

Who Issues and Buys Negative-Yielding Bonds?

Negative-yielding debt is not new in Europe and Japan where these bonds are issued by European and Japanese governments.  In Japan, the interest rate set by the government is below 0%. With a negative interest rate, the central bank charges banks for keeping deposits. This is a monetary policy that tries to encourage banks to lend out money and stimulate the economy. The same strategy has been used by the European Central Bank.

As countries put in negative interest rates, it leads to the creation of government bonds that have sub-zero yields. Investors still purchase these bonds as they have good liquidity and there are few options safer than a government bond. As more fixed-income securities become negative-yielding, the yields offered by bonds will continue to enter the negative territory. Thus, some investors buy bonds with negative yields because they believe future bonds will offer even worse returns. 

 

The Future of Bonds

Negative-yielding debt issued by governments also has a spillover effect on other fixed-income securities. Even high-yield bonds, or bonds that are considered higher risk, are offering negative yields. This is illogical to a lot of investors because, as the name suggests, high-yield bonds should be offering higher yields.

As mentioned above, interest rates set by the central bank impacts the yield of bonds. On July 31, 2019, the U.S. central bank lowered the rates for the first time in a decade. This caused the amount of debt with sub-zero yields to reach $14 trillion for the first time. With this increase, more than a quarter of investment-grade debt is yielding less than zero.

 

Additional Resources

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