3 ms·

@chadash thx for the explanation. With regards to > that investors think that rates of return on government bonds are going to go down in the future. Does it

@chadash thx for the explanation. With regards to > that investors think that rates of return on government bonds are going to go down in the future. Does it mean that investors think that US government will pay 'less interest' in the future for these 5 year bonds ? If yes, does that mean that investors think that US government will be willing to pay less to its lendors (the bond holders). Which, would also mean that bond buyers think it is good time now to lock in a higher rate. (seems like a good thing if one is a US taxpayer, if the gov will pay less to money lenders, unless US people are starving...). For example, Ukrain's 3 year bond pays 18% http://www.worldgovernmentbonds.com/bond-historical-data/ukraine/3-years/ http://www.worldgovernmentbonds.com/bond-historical-data/ukr...

chadash 8y ago
I didn't want to get too much into the weeds, but it's actually the market [1] that determines the rates. What the US wishes to pay is irrelevant. As stated in my original post, the treasury sets an interest rate and a face value on its bonds. Here's what that means (I'm gonna make up some numbers here to keep it simple): Let's say the US Government says we're gonna issue $100 of debt that's going to be paid back with 5% interest in one year [2]. If you were to buy that debt for $100, you would get $105 back at the end of the year, earning you 5% interest. That would be an amazing return for what's pretty much a risk free investment [3]. However, the trick is that they don't sell that note for $100. They auction it off to the highest bidder. So let's say that someone says I'm willing to pay $102 for that note. In that case, the effective yield for the investor is 105/102 - 1 = 0.029412, or roughly 2.9% instead of the original 5%. If the interest rate were 10% instead of 5%, investors would just bid more for those bonds, so the effective yield would be the same (the current yield that the market is willing to pay is about 2.62% for 52-week zero-coupon government bonds, AKA T-Bills), and the government would still effectively be borrowing at the same rate (though they would issue fewer $100 bonds, because each one sells for more). So back to your point, the rates are set by auction and don't have much to do with what the government is "willing" to pay to its lenders. What it means is that investors think that the market will be willing to pay more for $100, 5% interest notes in the future and therefore effective yield rates will be lower. There are many reasons why they may believe this (for example, ideas about what the Federal Reserve might do), but one of the main ones is a belief that the economy will slow down and stocks prices will fall, or be very volatile. When the economy is good and stock prices are going up, people want a piece of the action, so you they aren't willing to pay for the security of government bonds. But when the market is volatile or going down, investors want safety and are willing to buy government bonds at lower yields. [1] One can argue semantics on this. In reality, the Federal Reserve, and arguably foreign governments, distort the market somewhat. But let's ignore that for now. [2] This is called a zero-coupon bond, because you get all your money back at once. Most bonds are actually coupon bonds where for example, you buy the bond for $100 and get $1/year in interest for 10 years and then get your principal back at the end. However, I think the zero-coupon bonds are easier to describe, so I'm using those for this example. [3] Risk free because the United States government is constitutionally bound to pay its debts and has lots of instruments at its disposal to make sure that these debt payments happen. Sure, there can be a nuclear apocalypse that would prevent this from happening, but in that case, any other investments (other than weapons and canned goods) are worthless anyway. So it's viewed as fairly risk-free as compared to reasonable alternative investments (it's not free to store canned goods).

chadash 8y ago

I didn't want to get too much into the weeds, but it's actually the market [1] that determines the rates. What the US wishes to pay is irrelevant. As stated in my original post, the treasury sets an interest rate and a face value on its bonds. Here's what that means (I'm gonna make up some numbers here to keep it simple): Let's say the US Government says we're gonna issue $100 of debt that's going to be paid back with 5% interest in one year [2]. If you were to buy that debt for $100, you would get $105 back at the end of the year, earning you 5% interest. That would be an amazing return for what's pretty much a risk free investment [3]. However, the trick is that they don't sell that note for $100. They auction it off to the highest bidder. So let's say that someone says I'm willing to pay $102 for that note. In that case, the effective yield for the investor is 105/102 - 1 = 0.029412, or roughly 2.9% instead of the original 5%. If the interest rate were 10% instead of 5%, investors would just bid more for those bonds, so the effective yield would be the same (the current yield that the market is willing to pay is about 2.62% for 52-week zero-coupon government bonds, AKA T-Bills), and the government would still effectively be borrowing at the same rate (though they would issue fewer $100 bonds, because each one sells for more). So back to your point, the rates are set by auction and don't have much to do with what the government is "willing" to pay to its lenders. What it means is that investors think that the market will be willing to pay more for $100, 5% interest notes in the future and therefore effective yield rates will be lower. There are many reasons why they may believe this (for example, ideas about what the Federal Reserve might do), but one of the main ones is a belief that the economy will slow down and stocks prices will fall, or be very volatile. When the economy is good and stock prices are going up, people want a piece of the action, so you they aren't willing to pay for the security of government bonds. But when the market is volatile or going down, investors want safety and are willing to buy government bonds at lower yields. [1] One can argue semantics on this. In reality, the Federal Reserve, and arguably foreign governments, distort the market somewhat. But let's ignore that for now. [2] This is called a zero-coupon bond, because you get all your money back at once. Most bonds are actually coupon bonds where for example, you buy the bond for $100 and get $1/year in interest for 10 years and then get your principal back at the end. However, I think the zero-coupon bonds are easier to describe, so I'm using those for this example. [3] Risk free because the United States government is constitutionally bound to pay its debts and has lots of instruments at its disposal to make sure that these debt payments happen. Sure, there can be a nuclear apocalypse that would prevent this from happening, but in that case, any other investments (other than weapons and canned goods) are worthless anyway. So it's viewed as fairly risk-free as compared to reasonable alternative investments (it's not free to store canned goods).