What are negative yield bonds? – INSIGHTSIAS

GS Paper 3:

Topics Covered: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.

 

Context:

The amount of bonds circulating with negative debt yields appears to be dissipating in Europe.

• Global yields have been low for quite some time, and that accelerated when the pandemic struck in 2020 as investors piled into the safety of bonds.

 

What are they?

These are debt instruments that offer to pay the investor a maturity amount lower than the purchase price of the bond.

• Can be issued by central banks or governments.
• Here, investors pay interest to the borrower to keep their money with them.

 

Then, why do Investors buy such bonds?

• Such instruments are usually in demand during times of stress and uncertainty. This is to protect their capital from significant erosion.
• From currency fluctuations to deflation, there are scenarios in which purchasers of negative-yield bonds can come out ahead.

 

Relationship between Bond Price and Yield:

A bond’s price moves inversely with its yield or interest rate; the higher the price of a bond, the lower the yield.

The reason for the inverse relationship between price and yield is due, in part, to bonds being fixed-rate investments.

1. Investors might sell their bonds if it’s expected that interest rates will rise in the coming months and opt for the higher-rate bonds later on.
2. Conversely, bond investors might buy bonds, driving the prices higher, if they believe interest rates will fall in the future because existing fixed-rate bonds will have a higher rate or yield.

 

What is the key factor driving this demand today?

1. It is the massive amount of liquidity injected by the global central banks after the pandemic began that has driven up prices of various assets including equities, debt and commodities.
2. Many investors could also be temporarily parking money in negative-yielding government debt for the purpose of hedging their risk portfolio in equities.
3. In case the fresh wave of the Covid-19 pandemic leads to further lockdowns of economies, then there could be further negative pressure on interest rates, pushing yields down further, and leading to profits even for investors who put in money at the current juncture.

 

InstaLinks:

Prelims Link:

1. What are Negative Yield Bonds?
2. Relationship between Bond Price and Yield.

Mains Link:

Discuss why Negative Yield Bonds are gaining popularity these days.

Sources: Indian Express.