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A Reader Asks: How Can the Yield on a Greek Bond Be 650%?


Breaking down the confusion around investing in Greek bonds.

A Minyanville reader writes:

I've been trying to find out the answers to what I think are two basic questions about Greece and bond investments:

1. How is it that one-year debt can yield 650% while the yield on 10-year debt is only 33%?

This makes absolutely no sense to those of us that are not economists or bond traders, and none of the rest of the big picture is comprehensible without knowing the answer.

Trying to search on such yield inversion only turns up examples (as far as I can find) of cases where someone might accept slightly less for a longer term as they're concerned rates are going down and they might not get such a good rate in the future, but this doesn't explain anything like the Greek yields.

Is there some different default treatment for the 10-year bonds? Are investors tending toward paying more for shorter term debt, and are therefore not carrying the same level of default and/or haircut risks?

2. If the default and/or haircut risk is so high, then why would anyone buy Greek debt at this time?

Is it because the rate is so high, that even with the proposed haircuts and default risk, some feel it's a good gamble because if the "can is kicked" for just a few months then you're "in the money" even in the case of a hard-default? I'm not asking if you agree with the gamble, just if that is why anyone would risk the purchase right now.

But even that doesn't really makes mathematical sense if talking about 70% haircuts in a month, right?

Or, is it that some believe there won't be defaults/haircuts and are simply unable to resist the high rate of return?

Something else?

Thanks for any enlightenment you can provide.

To answer the first question, the yield you see when looking at these bonds is calculated to maturity. If you aren't familiar with bonds, most are issued at 100 (par) and trade up or down from there, which determines the yield. There is a fixed coupon (interest payment) that never changes despite the fluctuation in yield. Usually, these bonds are repaid at par when they mature, so a 1-year bond means it will be paid out at 100 one year after it is issued. The difference in price and yield is usually a representation of the fiscal health of a company or country over that time frame, meaning the odds that they will repay this debt in six months, a year, etc.

Click here for the definition of yield to maturity.

However, the reason for the large disparity in Greek bonds is this: Across the entire curve (different maturity of bonds), they are all at the price of $0.22 on the dollar. So, if you were to buy Greek 1-year bonds that mature in six months at $0.23, you are essentially making four to five times your money back in six months. However, the "yield," which is really "yield to maturity," is 650% because you are making back four times your money in half the time. Whereas 10-year bonds, which mature in nine years and are also trading at $0.22-0.23 on the dollar, will take nine years to return four to five times your money, hence the reason their yield is 33%. By Greek bonds trading at $0.22-0.23 on the dollar, this means that the investors in these bonds (largely European banks at this point) are expecting the value of their investment (NAV, or net asset value) to be reduced by 77-78%.

At this point nobody is buying Greek debt; I watch Greek bonds every day and only a few trades get done, if any (you can also see the liquidty by the bid/ask spread, similar to a stock). Over the last month, there has likely been little to no new money buying Greek bonds. The one thing moving is the bond that matures on March 20, because speculators were betting it could get paid back at par (it was trading at 28c, then 42, now back to 28) and they could quadruple or triple their money.

Right now there is no point in buying Greek bonds. I think Greek officials will force everyone to accept the agreement via the newly implemented Collective Action Clauses (or CAC) and risk paying out the net notional $3.2 billion in credit default swaps.

Twitter: @MichaelSedacca

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