Question

Explain why several government bond yields (including German, Finish and Swiss) turned negative in January 2015? Discuss the implications to issuers and bondholders.

Answer 1

Negative interest rate simply means that investors are charged interest for lending their money out to issuer companies, or while depositing their money in a bank. This type of regime comes into picture when the Central bank wants to encourage consumption/spending in the economy (for economic growth) rather than saving. Hence, investors are penalized for saving their funds.

Some Government Bond yields turned negative in Jan 2015 due to one or more of the following reasons:

1. Change in supply/demand of bonds-- A steep rise in demand of bonds will lead to an increase in price of bonds, which in turn will lead to a decrease in yields. Too much fall can subsequently lead to yields turning negative

2. Maybe the negative yields is actually potraying the economic downfall

3. Few investors require a certain sum of premium to buy bonds out of their preferred interest zones

Impact on bondholders- Negative yield means bondholders will lose money on the funds invested by them towards the issuer company. Hence this has a negative impact on the investment mindset of investors, as they wont be getting any incentive from investing their funds, meaning they are discouraged from lending out money for longer periods of time defying the time value of money concept

Impact on issuer - Issuer companies gain in this arrangement as their cost of raising funds decreases, issuers no longer have to pay positive yields (interest) to bond holders for laoning money, instead issuers can now charge interest from bond holders for loaning funds.