When to buy and sell bonds

Question

I am trying to understand the concept of when to buy and sell bonds of countries.

I am looking at Greek bonds. In the Financial Times newspaper there was a story saying

"Athens' two year bond yield maturing in April 2019 has hit its highest level in 8 months today, gaining more than 1.7 per cent since Monday, when the IMF voiced fresh concerns about the country's debt trajectory and growth prospects"

So I see that if there is economic instability in a country the yield goes up.

Why does the yield go up if the country is economically unstable?

The article further goes on to say that investors are selling these short term bonds heavily driving up yield.

Why does selling a bond drive up the yield?

If the country is economically unstable which is driving up the yield then isn't it a good time to buy the Greek bonds? Wouldn't you make money off of the higher yield?

I understand that the price of a bond and its yields are inversely related.

So if the yield goes up its price has gone down. But if you hold onto a bond until its maturity date, then, as well as making money on the higher yield, wouldn't you also get back the money you paid for the bond?

So if you think Greece is not going to default as it's highly likely a country would completely default, wouldn't it make sense to hold onto the bonds?

Or is it the case that if yields have gone up, then the price of the bond has come down so you get less money paid out if you let the bond mature?

Answer 1

Why does selling a bond drive up the yield?

The bond will pay back a fixed amount when it comes due. The yield is a comparison of what you pay for the bond and what will be repaid when it matures (assuming no default).

Why does the yield go up if the country is economically unstable?

If the country's economy is unstable, that increases the chance that they will default and not pay the full value of the bonds when they mature. People are selling them now at a loss instead of waiting for a default later for a greater loss.

So if you think Greece is not going to default as it's highly likely a country would completely default, wouldn't it make sense to hold onto the bonds?

Only if you also think that they will pay back the full value at maturity. It's possible that they pay some, but not all. It's also possible that they will default. It's also possible that they will get kicked out of the Euro and start printing Drachmas again, and try to pay the bonds back with those which could devalue the bonds through inflation.

The market is made of lots of smart people. If they think there are reasons to worry, there probably are. That doesn't mean they can predict the future, it just means that they are pricing the risk with good information. If you are smarter than the herd, by all means, bet against them and buy the bonds now. It can indeed be lucrative if you are right, and they are wrong.

Answer 2

Why does the yield go up if the country is economically unstable?

The yield will rise when instability increases because the risk of default increases. If the case of Greece, the instability of government finances resulted in a 50% "haircut" for bond holders in 2011. In other words, bond holders suffered a 50% write down in the nominal value of their bonds. This means that holding these bonds until maturity will mean they will only receive half of the original nominal value of the bond, and that is assuming no further write downs occur.

Why does selling a bond drive up the yield?

Significant selling of bonds means that sellers are worried about future prospects. Sellers will outnumber buyers, so sellers will have to reduce their offer price in order to attract new buyers.

So if you think Greece is not going to default as it's highly likely a country would completely default, wouldn't it make sense to hold onto the bonds?

If you think that it is highly unlikely that Greece will default and the prices and yields are attractive, then Greek bonds may look like an attractive investment. However, keep in mind the fate of bond holders in 2011. They were attracted to Greek bonds by the price and yield, but they suffered a 50% haircut.