Definition
Negative yield bond refers to a debt security that costs more to buy than the overall cash return it generates over its life cycle. This means that investors are effectively paying the issuer to hold their money instead of earning interest on their investment. Negative yields typically occur during periods of extreme market stress or economic downturn.
Key Takeaways
- Negative Yield Bond refers to an unusual situation where issuers get paid to borrow. Investors purchase them with the understanding they will receive less money than they paid at maturity.
- Investors may buy Negative Yield Bonds anticipating worse economic conditions in the future, making these bonds potentially better investments relative to others.
- Negative Yield Bonds signal a bear market, weakened economy or deflation, often seen as safer houses for storing capital in uncertain or turbulent economic periods.
Importance
Negative Yield Bonds are essential in finance because they offer insight into the health of an economy, reflect investors’ expectations, and influence monetary policy decisions.
Despite an investor receiving less money at maturity than the original purchase price, these bonds are purchased in expectations of deflation, further drop in interest rates, or as a safe haven during uncertain economic periods.
Central banks often use negative interest rates as a monetary policy tool to stimulate economic growth.
This unusual phenomenon of investors willing to take a loss could signal a system saturated with excess liquidity, a lack of profitable investments, or a pessimistic economic outlook.
Thus, these bonds can significantly influence the global macroeconomic environment.
Explanation
Negative Yield Bond is an instrument used in the financial markets during periods of financial stress or when economic conditions are not favorable. As a counter-intuitive investment, its purpose serves a broader strategy to protect investments and funds against abrupt market changes or inflation. In normal circumstances, when an investor purchases a bond, they receive regular interest payments and the principal sum at maturity.
However, with Negative Yield Bonds, the interest achieved over the life of the bond is less than the initial amount paid. In a nutshell, investors are willing to pay more for the bond than the amount they will receive back at maturity. These bonds are principally utilized by investors when the market forecasts deflation or when safe asset options are significantly limited.
In such instances, preserving fund value or avoiding loss may hold greater importance than making profits. Furthermore, while individual investors have negligible reasons to hold these bonds, institutional investors may do so to meet specific requirements, such as pension funds and insurance companies whose regulations mandate certain fixed income investments. It’s also worth noting that these bonds can provide benefits if sold before maturity, especially if bond prices rise, allowing the owner to sell it at a higher price.
Examples of Negative Yield Bond
German Government Bonds: One of the most prominent real-world examples of negative yield bonds is the German government bonds or bunds. In 2019, Germany sold a 30-year bond with a zero coupon, meaning it pays no interest, and at auction, it sold for more than its face value which resulted in a negative yield. Investors, in essence, were paying the German government for the privilege of lending it money.
Swiss Government Bonds: Another prominent example can be seen in Swiss government bonds. For many years now, most of the Swiss Confederation bonds have negative yields as investors essentially pay the Swiss government to keep their money safe.
Japanese Government Bonds: The government bonds in Japan also often have negative yields. Japan has struggled with low inflation and low economic growth for years, and the Central Bank has kept interest rates at extremely low levels to encourage economic activity. As a result, Japanese Government bonds, particularly for shorter-term bonds, frequently have negative yields.
FAQ: Negative Yield Bond
What is a Negative Yield Bond?
A negative yield bond is a debt security that costs more to purchase than the total amount a person will receive throughout its entire life span, including all interest and principal repayments. Investors pay more for the bond than they will eventually receive in return, hence the concept of ‘negative yield’.
Why would anyone buy a Negative Yield Bond?
Investors might buy negative yield bonds for different reasons. Despite the negative return, these bonds can offer certainty and act as a safe haven in volatile markets. Furthermore, some institutional investors are required by mandate to hold certain types of these bonds. Also, investors may buy these bonds if they expect interest rates to fall further, hoping to sell at a profit later.
How does a Negative Yield Bond work?
A negative-yield bond works when the interest rates are so low in the market that investors are literally willing to lose money to keep their money in a safe and liquid market. The yield, or total return on the bond, is negative as the price of the bond is higher than the overall income the bond will generate.
What is the impact of Negative Yield Bonds on the economy?
Negative yield bonds can impact the economy in various ways. They tend to signal a lack of confidence in the economy, as investors are willing to take a guaranteed loss rather than risk investing in other more profitable, but potentially risky ventures. Additionally, they can also depress interest rates further, creating a challenging environment for banks and other financial institutions. However, it’s important to note the economic impact can vary depending on several other factors.
Related Entrepreneurship Terms
- Nominal Yield
- Global Bond Market
- Interest Rate Risk
- Bond Maturity
- Investment Return
Sources for More Information
- Investopedia: Provides definitions and detailed articles on thousands of financial terms and strategies, including negative yield bonds.
- Bloomberg: Trusted for up-to-date financial news and analysis, which often includes insights on bond yields and market trends.
- Reuters: Offers global financial news, including deep dives into bond yields.
- Financial Times: Provides articles and opinion pieces on global financial markets, including bonds.
