So I think that the best time to buy a bond is in a recessionary environment…is this because the bond yield is high? For me I struggle between the difference between a bond yield and interest rates. Is the bond yield high because of a higher coupon being offered or because of its low price, or both? In a recession, interest rates would be low to stimulate the economy, wouldn’t this lead to high bond prices, why would i want to buy a bond with a high bond price? I’m a bit confused, pls. help!
Bond yields are generally low in recessionary environments because interest rates are low. The yields on any fixed income security is based upon the appropriate yield curve. Treasuries have low yields during a recession, especially at the lower end of the yield curve. High quality corporate bond yields are still relatively low during a recession, but they are going to be higher due to the credit spread above treasuries. Lower credit quality = higher spread. Coupon rates have nothing to do with it, as the only bonds affected are going to be those issued during the recession. New bonds issued in a recession would carry coupon rates reflective of the appropriate market yields (otherwise nobody would buy the issues). And, the reason you would want to buy bonds in a recession is that equity prices are falling and high quality bonds are generally safer than stocks… Remember, bonds have seniority over equity (except in the case of government owned car companies). This is what’s called flight to quality, and is why we had negative short term treasury rates in recent times.
Wow thanks so much for the fast response McLeod, that helps. Thanks again.
Any time
I’m sorry to be an idiot. Does it say somewhere in the curriculum that you should buy bonds in a recession? I mean you could if at the beginning. The way I see it the best time to buy them is during slowdown. Because of prior expansionary cycle, yields are high, and coming into recession decrease in interest rates would increase bond prices. It makes a lot of sense to hold bonds in a recession but buying would be better to be done right before, in my opinion.
It would be best to buy the bonds before the collapse in yields in order to profit from their price appreciation. So you would want to buy them in the slowdown while they are still cheap. If one waits until everyone else is buying them, you’d miss out on a good amount of price appreciation. The opposite may be true when you consider corporate credit spreads, which may have peaked at the same time as treasuries prices (short treasuries and long BB rated?)
Typically bond markets recover before stock markets which recover before commodities recover. I think that’s somewhere in the stuff on economics and capital markets expectations. Bond yields (for straight bonds) are composed of a Risk-Free component, representing the time value of money and a set of risk premia, of which the biggest one is typically credit risk (liquidity risk is another one). In a recession, the monetary authority will typically try to lower interest rates, which it can do with many mechanisms - one big one is open market operations, where they buy and sell treasuries to achieve a target fund rate, which is basically the risk-free rate. Increased fiscal spending as in a stimulus plan can make this more difficult, since more federal demand tends to push treasury rates up. In a recession, the credit spreads tend to widen, because when the equity is in trouble, then the bondholders are in danger of not being paid either, and so bond investors demand more return to compensate for that risk. Corporate bond yields can rise if credit spreads increase faster than the risk-free rate falls, which is what happened in the fall of 2008 and has only lessened a bit recently. In a perfectly efficient market, a corporate bond portfolio that is fully diversified across issues ought to be equally attractive at pretty much all times, at least compared to a treasury. In bad times, you’ll get higher yields, but also higher risk of default (at least for corporates). In good times, the yields are lower, but you’re more likely to be paid back. If markets are efficient, these effects should balance each other out and give you more or less the same realized yields. If you are better than the market at picking out who will default and who won’t, then there’s an opportunity for alpha generation by taking the higher yield. Markets may not be efficient, but the principle is that if yields go up, you still need to ask yourself if it means you are taking on more risk. What got a lot of people in trouble in this crisis was something called “reaching for yield,” where people (and pension funds and endowments) bought things because the yield was good, and thinking that the risk had not increased proportionately. Then they discovered that they actually had much more risk on their books than expected, and that the yield had not paid them enough to save them, and diversification didn’t seem to work. It’s more complicated than that, but you just need to be aware that if you are looking for spreads over and above treasuries, it usually means you are taking on more risk, so make sure you understand the risks your taking and control your exposure.
McLeod agreed 100% Actually I’m kicking myself for not buying some high yield bond etfs. I might though if there is a weakness.
bchadwich you might be correct if you think markets are efficient, which I don’t think is the case. Indeed there should not be a lot of ‘free lunches’ but sometimes the market will go too far with the widening of the spreads. It’s always one’s opinion against another’s which makes the market always exciting
I don’t believe that markets are perfectly efficient, but I do think that exploitable inefficiencies can be hard to find. All I’m saying is that when yields go up, don’t just jump in thinking “I gotta get me some of that.” Take some time to think about what you know that the market doesn’t, and how strongly you believe you are right before doing it.
that’s for sure. the yield is high because of the risk and the probability of somebody to actually receive that yield is close to 0% (if you buy an etf some bonds will default) the only problem is if you take defaults expected by you into account what that adjusted yield will be and if it will be enough reward
There’s a point where the yields just start to look ridiculous. If HY bonds are priced at a yield of 20%, you could have half of the bonds default with a 25% recovery rate and you’d still be earning 12.5%.
plus looking at the respective Treasuries, at one point, if you believe economy will recover, those yields will have to come down. That’s why bonds tell better the recovery story - since they represent financing costs for companies that really need them. without lower financing recovery is far, I believe
Will it be a representative bias? As over trillions (in US$) of bond value will be issued in 2009?