What's Wrong With This Picture?

I don't see a problem. Bonds went down because interest rates went down, no?
 
So the bonds are more expensive and the interest stays the same and so you get less despite paying more (the yield)? Guess the person who sold the bond for a profit is happy though?
 
FrankieK said:
Investors are yield starved because of low interest rates so they pile into bonds pushing the bond price up and the yield down. Once interest rates start to rise bond prices will get decimated leaving investors holding the bag.
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I'm not sure Im following the logic of the article. A bond price is fixed.
That means when i buy for R 100 today with a 10% yield. I will get R110 back guaranteed by the institution.
If bond prices do go down in between then I still get my R 110, the contract is set.
Bonds dont work like shares, your capital is guaranteed.

Bill Gross's arguement on bonds relates to something else...more on liquidity.
 
bchip said:
I'm not sure Im following the logic of the article. A bond price is fixed.
That means when i buy for R 100 today with a 10% yield. I will get R110 back guaranteed by the institution.
If bond prices do go down in between then I still get my R 110, the contract is set.
Bonds dont work like shares, your capital is guaranteed.

Bill Gross's arguement on bonds relates to something else...more on liquidity.
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Bond prices do change once they are in the secondary market. Your payout is fixed but the price of the bond in the market is determined by the interest rate.

Interest rate goes up - bond price decreases because the PV of the future pay out decreases.
 
FoXtroT said:
Bond prices do change once they are in the secondary market. Your payout is fixed but the price of the bond in the market is determined by the interest rate.

Interest rate goes up - bond price decreases because the PV of the future pay out decreases.
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The par value of the bonds are set, even though the prices of the bonds fluctuate.

I take you mean only if you sell in the secondary market?
If you bought (even in the secondary market) and held to maturity it would not have affected you.
 
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So if someone bought @ 100 par value with a 10% coupon end of the year and 100 for the price = 10% return.

Then the bond markets crashed and the price is now trading at 50 (par value is still 100 and 10% coupon) = 50+10 =60% return

Why would I sell at 50 and get a 50% loss....why wouldnt I rather buy @ 50 and get a 60% return?
or hold and get a 10% return?
 
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bchip said:
So if someone bought @ 100 par value with a 10% coupon end of the year and 100 for the price = 10% return.

Then the bond markets crashed and the price is now trading at 50 (par value is still 100 and 10% coupon) = 50+10 =60% return

Why would I sell at 50 and get a 50% loss....why wouldnt I rather buy @ 50 and get a 60% return?
or hold and get a 10% return?
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You wouldn't want to sell at 50, as you said you would want to buy.

Essentially bond prices are all about staying in 'equilibrium'.

If you get a one year bond of R100 par value with a coupon value of 10%, the value of your bond is at year end R110.

Now imagine the interest rate rises to 15%. Out in the market people are now able to get R100 par value bonds at a 15% coupon so their year end value would be R115.

Investors won't want to buy the original bond anymore and would instead move to the new one because of the better return. In order to remain attractive at this interest rate the original bond would have to decrease in price to around R95.

At that price the two bonds would be equivalent to each other in terms of yield.

This calculation can obviously become more complicated when you look at different terms to maturity and coupon payment periods.
 
supersunbird said:
So the bonds are more expensive and the interest stays the same and so you get less despite paying more (the yield)? Guess the person who sold the bond for a profit is happy though?
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Not really. When bond yields go negative like the German 10Yr this week investors have to pay the interest on those Bonds
 
FoXtroT said:
You wouldn't want to sell at 50, as you said you would want to buy.
Essentially bond prices are all about staying in 'equilibrium'.
...
Investors won't want to buy the original bond anymore and would instead move to the new one because of the better return. In order to remain attractive at this interest rate the original bond would have to decrease in price to around R95.
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I get how this works, what Im asking is from my perspective/portfolio point of view:

If there is a BIG crash in the markets, what is MY risk?

If bond values move down and I bought @ 100 and theres a big bond crash
and its now trading at 50 then why sell?
If I dont sell I still get my 10% return.
If I sell I get a 50% loss.

I dont see what the "doom and gloom" is about a bond crash.
Thats why I'm asking, what am I missing that everybody else is so worried about?

A big risk is major defaults on what you bought, not the pricing on the secondary market.
 
bchip said:
I get how this works, what Im asking is from my perspective/portfolio point of view:

If there is a BIG crash in the markets, what is MY risk?

If bond values move down and I bought @ 100 and theres a big bond crash
and its now trading at 50 then why sell?
If I dont sell I still get my 10% return.
If I sell I get a 50% loss.

I dont see what the "doom and gloom" is about a bond crash.
Thats why I'm asking, what am I missing that everybody else is so worried about?

A big risk is major defaults on what you bought, not the pricing on the secondary market.
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Its not a big issue if you are planning on holding the bonds to maturity. If you are trading bonds (i.e. trading interest rate and credit risk) then it is a big issue.

Also if interest rates don't change much but the price of a bond falls significantly, that would indicate that there is a significantly higher chance of default occurring on that bond, which is not good for the "hold to maturity" crowd either since you might not get your cash back at maturity.

Also, most bonds almost never sell at face value even on day 1 because the contractual coupon will almost never be exactly what the prevailing interest rate is on the day of sale.
 
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