100/(1.015)^10 = 86.1667
100/(1.07)^10 = 50.8349 (this how much a 7 percent 10 year 100 Euro bond would sell at auction)
this is so wrong it is unbelievable
if spain issued a €100 face value 10 year bond yielding 15% it would sell for a price far in excess of €100. with current market interest rates where they are a 10 year bond yielding 7% would sell for about €100.
so imagine it issues both and imagine the 15% one sells for €160. what happens to the price when spain looks like it won’t be saved? market interest rates increase. and so the price of that bond falls. if market interest rates increase to about 15% the price of that bond will fall from €160 to about €100
the 7% yielding bond will also fall in price as market interest rates increase. this is so the subsequent amortisation of price back up to par over the remaining life is a substitute for the missing interest in the coupon *8% is missing compared to the market interest rate)
so what is the problem for spain? i mean, if the price of all their bonds has fallen why don’t they just by them back at a discount to where they sold them? well, for starters they’ve spent all the money. so the issue now is as 4% coupon debt expires, they now have to issue 7% coupon debt. and given the magnitude of their debt burden and their enormous budget deficit, this will soon mean that they cannot afford interest payments. and they’ll default on their debt.
i’m skipping the rest of the mathematics and going to…
I mean think about it. If you actually thought Spain was going to default, you would charge a hell of a lot higher interest than just 7 percent annualized.
no. people do think spain is going to default and they are only charging 7%. why? because they think that if spain threatens to default the ecb and the rest of europe will cave in and bail them out (then 7% coupon when 10 year treasuries return less than 2% will seem like a great investment)
But that’s an arbitrage opportunity. It is an arbitrage opportunity that a computer couldn’t spot, but it was definitely an arbitrage opportunity.
it’s not an arbitrage opportunity. it is a risk opportunity. what happens if spain is not bailed out when they try to default? then not only do you say goodbye to the 7% you say goodbye to your capital as well. then the 10 year treasury looks like a great investment decision.
The difference was between the world it is right now and the world that had to be. The European Central Bank had to be a central bank to all of Europe. And if you knew that, you could’ve not worked at all this year. Well, you worked. Just like with your brain instead of like regular working.
this paragraph makes no sense at all
What will happen now is that because of the Basel banking rules requiring banks to hold government bonds, the next time the ECB buys Spainish bonds at 1.5 percent, all the banks in Europe will buy your 7 percent bonds at like 1.7 percent prices or whatevers. And you get like 65 dollars on your 100 dollar investment.
that is not true. basel requires banks to hold capital of a certain quality in a certain proportion to their assets (their loans). if spain is downgraded further, then the ability of a bank to use spanish government debt as capital to meet basel requirements is diminshed and they must find alternatives. this in turns leads them to sell those bonds to buy the alternatives (10 year treasuries for example) further driving the price of the spanish ones down (the yield up past 7%) but whether to 65 cents on the dollar is another question your mathematics is not equipped to answer
I guess it would be in Euros. But anyways, it’s a lot of free money. FREE money!
it’s not free money. the fact they’re paying interest on it shows it is not free. the fact that as interest rates go up bondholders suffer a loss shows that too.
If you invested 1 billion Euros, you’re looking at 650 million Euros in return over just maybe like 4 or 5 months. That’s like a 150% annualized return. That’s way better than any hedge fund you’ll ever find.
if you invested €1 billion in spanish bonds right now you better hope mario draghi gets permission to bail them out. if he does, you might just save your capital from the gouging losses that would otherwise be experienced if they were allowed to default. the only problem is, by the time your investment matured, the 7% yield you might be getting might not be enough to cover the inflation that might be caused by the bailout. a classic catch-22 position
I wanna run the Saudi Arabian sovereign fund so bad. I’d do a good job conquering the world.
if this is how you choose your investments the saudis would not let you touch one dinar. and if this is how you decide what your return is then i’m sure climbimg a hill would lead you to believe you are in fact king of the world.
It’s just like a video game.
no it’s not. while traders do sit in front of screens all day it is more chess than WoW
It gets a little trickier with the currency carry trade. But if you lived and worked in Europe, this was what you should have done. Bought a whole shit load of Spanish and Italian bonds. Well, not NOW. Before.
i hope you don’t have a spanish grandmother and italian aunt you are advising. because if you had you might not be so popular at christmas given how much money you’d have lost them
This money had to come from somewhere though. It’s a little zero sum and possibly quite wealth destroying. It came from money banks could have used to invest in small businesses. It came from the velocity of money in Europe, which is really the absolute worst thing ever. But what do you care? 69 percent! Heehee. 69.
a little zero sum is an oxymoron. either something is or it isn’t. if it is zero sum then any increase in yields is definitely wealth destroying. and because you are talking about sovereign debt, why are you now mixing in talk of lending money to businesses which is not something the spanish givernment generally does as a day job?
Screw everybody else. They’re just going to break your heart anyway.
Eventually though, they’re going to scrap the Basel rules because they have to, which means there is going to be a shit load of money that all of sudden has to go somewhere.
why do they have to? please explain? if your explanation is anywhere as entertaining as what you have said previously i’m sure we could all make millions just knwoing what your explanation is
These few months and years will really require some active management.
try some active learning and reasoning before you try any active management