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If I asked you for $100 and your mother asked you for $100, you'd charge me more interest, because I'm [hopefully] a higher risk [from your point of view]. The
by latch 15y ago
If I asked you for $100 and your mother asked you for $100, you'd charge me more interest, because I'm [hopefully] a higher risk [from your point of view].
The interest paid on bonds is directly related to the risk of holding the bond (or, the perceived risk). A high interest rate (which the government pays) is the only way the government can get people to buy its bonds, because it's considered a high risk.
It pretty much means that, people aren't expecting Greece to be able to pay back its debt in 2 years. Which is really bad, normally, short term bonds have lower rates (because the risk is lower)...but now, even at 2-years, people see huge risk.
People want 75% interest on, what is essentially, a 2 year loan. Compare that to other parts of the world where you're taking 3% on 20 years....20 years is a long time, anything can happen, but even over such a huge difference in time scale, greece is a much, much, higher risk.
- chocoheadfred 15y agoThanks. If I bought these bonds and they actually paid back, if get a 75% return? So, how is risk calculated...quantitatively or more gut?
- wladimir 15y agoYes. It's kind of a "double-or-nothing" casino game. The yield is determined by the free market, it's the amount that Greece has to (promise to) pay for anyone to take them. It's not determined by a formula afaik, just based on current events and the state of the country's finances. I don't think you can invest (or rather, speculate, this is too crazy to call investing) in these as normal retail investor though.
- illumin8 15y agoTo be clear, the yield is determined by the free market as the price they pay for the bond. If the bond was originally priced at $100, with a 1% coupon payment (the amount the government or bond issuer will pay you in interest), if the resale value goes down to $50 in the open market, then the yield has doubled to 2%, since a new owner of the bond only had to pay $50 to get the same $1 coupon payment while holding the bond.
- fr0sty 15y agoRegardless of whether the bond has a coupon payment or not the face value of the bond is due at maturity. In your example the $1 coupon is still paid but in two years you also get $100 back on your $50 purchase (netting 20+%apy). Of course if the government defaults on your bond you get maybe on $1 coupon and end with a net loss of $49.
- illumin8 15y agoAh yes, you're correct. So my yield is way off. Thanks for the correction.
- goodside 15y agoRemember that rates are always given as annual rates. If you buy $100 in two-year bonds, in two years you get about $303 back, or ($100 * 1.74^2).