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German feedback (continued)

07 May 2015
Richard Kemmish

As per my last post, some more comments heard at the Euromoney Germany conference, and my own thoughts on some of them. 

‘There is a significant difference between a bond that can’t pay a negative coupon and one that won’t’.
If we accept that negative coupons are impossible and that issuers won’t try to get their money back at maturity, what is the difference between a bond referenced to 3 month euribor with a floor of zero and a bond references to 3 month euribor where the issuer won’t bother trying to collect negative coupons?
Two that I can think of: firstly, from the investor’s perspective, a floor is technically an option, therefore the note is technically a structured product, therefore the repo and clearing treatment makes it more expensive to own. Secondly, from the issuer’s perspective, the second bond will probably have an associated swap without a floor, the first bond’s attached swap will have a floor. So the issuer of the second bond is unhedged and makes a windfall loss when rates go negative The other issuer doesn’t.
'Yields and coupons on new bonds will increasingly diverge'.
Historically syndicate desks set the coupons on bonds at the nearest round number to the yield on the bond to allow bonds to price very close to par, thus avoiding, for example capital gains tax problems for investors. In the new paradigm it is far easier to avoid all of the difficult conversations about no or negative coupons if you simply sell a bond for more than par value with a proper, ie positive coupon materially above the yield. Which will create a whole load of new accounting and tax problems for some classes of investors.

'My girlfriend told me that the bund future can’t technically go over 160’.
This comment shocked me on two levels. Firstly why not? Just because it was inconceivable that rates would go negative when it was decided that the bund future should be based on a note with a nominal 5% coupon doesn’t mean that any limits on the trading price should have been set. Secondly, what kind of conversations do some people have with their girlfriends? Romance is dead.

‘The interest rate downside scenario in the recent EIOPIA stress tests is above current market rates’.
At least the insurance regulators think that rates can’t stay this low for long.

‘German investors will become less parochial'.
Just as Japanese pension funds have started to materially invest outside Japanese fixed income in response to the current levels of JGBs, so German investors will buy more non-German assets, reversing the trend since the crisis.

‘I need a new bond calculator’.
I checked, my trusty HP12C (showing my age there) can’t cope with negative yields, neither can the duration function in Excel.

‘To find a positive yield all investors are currently looking to add duration and credit spreads’.
According to Stein’s law, interest rates will rise one day. What could possible go wrong?

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