A lot of the papers have mentioned that Greek bond yields have risen to 20 per cent because investors fear that there will be a partial default, or "haircut" or "restructuring" or whatever you want to call it.
Does this mean that Greece is paying 20 per cent interest on its bonds? Nope, the gimmick here is that investors have priced in the probability of default and Greek bonds are being bought and sold at seventy per cent of face value.
So crudely speaking, those who invested at par a few years ago have lost 30 per cent of their investment; and if (for example) you now buy a Greek bond with three years to maturity paying nominal 10 per cent interest for 70 cents in the Euro, over three years you will receive 10 cents interest every year and 100 cents in three years' time, giving an internal rate of return of about 20 per cent (assuming no default).
In a worst case scenario, you would only receive 50 cents principal repayment in three years, giving an IRR of 4 per cent (assuming interest paid in full).
So it's the 4 per cent yield which is the relevant figure, which seems not unreasonable in today's low interest rate environment, and not the 20 per cent.
Wednesday, 20 April 2011
Greek Bond Haircut Fun
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16 comments:
Ignorant aren't they? But it does imply that Greece would have a pay a much higher interest rate to raise money from the bond market - if she even could.
When the greek gvmt sells new bonds they will only receive 70% of face but with the full coupon so they will be paying 20%. Are you saying that the article says that 50% default per bond is planned and accepted by both gov and market.
L, D, that's the clever bit. Greece is now borrowing very short term, and is paying 'only' 4.1%. It does NOT have to pay 20% on anything at all.
This is because the likelihood of a default in the next three months is only one per cent, but a likelihood in the next three years is fifty per cent (or whatever the probabilities are).
Yeah. We only ever buy short dated bond funds, because there is insufficient reward in the yield for the risk taken by the buyer on loger dated issues. Index Linked issues are less vulnerable to this, principally I think because they are only issued by AAA countries (AFAIAA) and the default risk is low. Mind you, would you buy a 30 year index linked Gilt?
MW and isn't Greece also selling its new debt at a discount?
L, I very much doubt it, shorter dated stuff has interest rate 4.1% which I assume is issued at face value. Or maybe it's zero-coupon issued at 95.9, same difference.
MW - I just thought I read that somewhere recently - like you I doubt it, but...
Thinking about it a bit more, I think what I read was that they were offering 3 month bonds at say 96% of par. So that is a higher annual rate. 1.04^4 = approx 17%? I cannot actually recall whether or not there was a yield as such? Does that make sense. (I really haven't the time at the moment to look this up - aplogies)
L, Good point. If they are 3-month zero coupon bonds with eff. annual interest rate 4% then they would be issued at 99% of face value, same as T-bills.
No way are they paying 16% for three month borrowing, they'd have melted down long before it gets that bad.
I think they were zero coupon bonds, which would make sense as Greece realy cannot afford the cashflow requirement.
I might also bet that they will find three month month increasingly difficult to find, unless it comes from 'tame' Euro institutions or some Euro central cash pool. I mean would you lend Greece money for three months now? No, neither would I.
L, why does it make any difference whether they borrow 99 and repay 100; or borrow 100 and repay 101?
MW well, I could be pedantic and say that 1/99 is bigger than 1/100, but I don't think that's your question.
The points I was trying (badly?) to make about Greek sovereign debt are:
They may well be borrowing at 16% or 20% p.a. or whatever, IF they can only raise short term money perhaps <3months, and that they were not able to afford the cashflow of the coupon, and that hence the yield was expressed as a discount, and that discount may be 4% or whatever and that is was over the duration of the bond which made the effective annual rate say 17%.
Meanwhile, existing Greek debt is traded at a discount sufficient to make the redemption yield approx 20%.
It seems to me that if the bond market is saying that existing Greek debt needs to be priced at 20% then it will be pretty damn' difficult to sell new debt on the open market for less than that figure.
Then into the mix comes the bloody EU. They have two agendas, First and foremost to preserve the Euro project at whatever the cost to anyone else and secondly to try and sort out Greece. The latter agenda would make them want to offer Greece lower priced debt than the open market, but I would bet my bottom dollar that overall hidden in the details they won't be, and Greece like Ireland et al will be in hock to the EU shits for the full rate.
L: "It seems to me that if the bond market is saying that existing Greek debt needs to be priced at 20% then it will be pretty damn' difficult to sell new debt on the open market for less than that figure."
It's only the longer dated stuff (three years and up?) which is trading at 30 per cent discount and thus has eff. return 20 per cent. They can still borrow short (up to three months?) at around 4%.
MW - Thanks. I presume you've checked that? Because I'd heard that they were paying 4% for 3month money, as in selling 100 of debt for 96 with three month redemption?
L, yes, as far as is possible. If they sold 3-month bonds for 96, then that is indeed an interest rate of 16% and entirely unsustainable.
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