17

I read this in the news regarding Greece's financial crisis:

The country’s 10-year bond yield fell 11 basis points to 8.04 percent at 12:26 p.m. in Athens today. While that’s down from a record of 42 percent on the eve of the biggest debt restructuring in history in 2012... (Source)

From what I understand, bond yield is basically the same as an annual interest rate and fixed until maturity. But it seems unreal to offer 42% interest for 10 years even if the country was likely to default. Is my understanding wrong, or were these bonds really available for investors? In other words, is Greece paying someone 42% interest until 2022?

  • 5
    Yield is different from interest. The figure you quoted is the yield, primarily the money received by Greece was very low, meaning for a 100 euro bond, Greece received maybe 50, which you need to calculate. And this isn't related to personal finance. Modify your query or else it might get closed. – DumbCoder Dec 18 '14 at 11:54
28

Your understanding is indeed wrong. Bond yield is the effective interest rate relative to the current market price of the bond, and it is anything but fixed. There was never anyone actually paying or receiving 42% interest in the whole affair.

What happened is that bonds with a nominal interest rate of perhaps 10% (for simplicity's sake, and probably not too unrealistic at that point) were selling at less than 25% of their nominal value.

Basically, there were bonds that said "The Greek government will pay you 100 EUR in 10 years, and until then 10 EUR each year", which someone had originally paid 100 EUR for, but now people were only willing to pay about 24 EUR for them (which would have made the 10 EUR per year a 42% ROI). Why were they only willing to pay that little? Because at that time everyone thought that there was a pretty good chance that Greece would default and they would get neither the 10 EUR interest payment nor the 100 EUR principal in 10 years, and instead would end up losing the 24 EUR they had just paid.

What actually happened was a debt restructuring with the effect that Greece is now paying back considerably less, both yearly and at the end of the maturity period, which means that the people who paid 24 EUR for those bonds are getting a much less spectacular ROI (not sure how much exactly, but probably still pretty good, after all they did bear a considerable risk of total loss).

The takeaway? A high bond yield is actually a big warning sign when you're looking for an investment, because it means the market thinks it's a high risk investment.

  • 3
    +1, but your takeaway (high yield = "bad thing") cannot be known to be true. In an ideal, 100% efficient market all (liquid) investments have the same expected ROI b/c the yield balances out the risk. So a collection of high yield instruments might have more defaults, but the ones that don't default pay more money. The real (highly inefficient) market that we actually live in rarely balances out like that, but nobody can know in advance whether the yield:risk ratio for a particular batch of investments is too low (bad for investors), too high (good for investors), or just right. – dg99 Dec 18 '14 at 17:49
  • 1
    Why do you say the market isn't efficient? "nobody can know in advance whether the yield:risk ratio for a particular batch of investments is too low (bad for investors), too high (good for investors), or just right." is pretty close to a common definition of efficiency. – Evan Wright Dec 18 '14 at 19:22
  • Uncertainty is orthogonal to efficiency; they are unrelated. Market efficiency means that prices reflect all available information. Certainty reflects how much information is available in the first place. So you could have 100% certainty about the future, but if nobody acted on that info you'd get 0% efficiency. Or if everybody acted the wrong way, -100% efficiency. Or you could have 1% certainty about the future, and if everybody acted on that info you'd get 100% efficiency. And any other combination you can imagine ... – dg99 Dec 18 '14 at 21:05

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.