why investors buy negative yielding bonds
investors that are interested in buying negative yielding bonds include central banks insurance companies and pension funds as well as retail investors however there are various distinct reasons for the purchase of negative yielding bonds many hedge funds and investment firms that manage mutual funds must meet certain requirements including asset allocation asset allocation means that the investments within the fund must have a portion allocated to bonds to help create a diverse portfolio allocating a portion of a portfolio to bonds is designed to reduce or hedge the risk of loss from other investments such as equities as a result these funds must own bonds even if the financial return is negative bonds are often used to pledge as collateral for financing and as a result need to be held regardless of their price or yield some investors believe they can still make money even with negative yields for example foreign investors might believe the currency s exchange rate will rise which would offset the negative bond yield in other words a foreign investor would convert their investment to a country s currency when buying the government bond and convert the currency back to the investor s local currency when selling the bond the investor would have a gain or loss merely from the currency exchange fluctuation irrespective of the yield and price of the bond investment domestically investors might expect a period of deflation or lower prices in the economy which would allow them to make money by using their savings to buy more goods and services investors might also be interested in negative bond yields if the loss is less than it would be with another investment in times of economic uncertainty many investors rush to buy bonds because they re considered safe haven investments these purchases are called the flight to safety trade in the bond market during such a time investors might accept a negative yielding bond because the negative yield might be far less of a loss than a potential double digit percentage loss in the equity markets for example japanese government bonds jgb are popular safe haven assets for international investors and have at times paid a negative yield example of a negative bond yieldbelow is an example of two bonds one of which earns income while the other is negative yielding by the time of the bond s maturity bond abc has the following financial attributes bond abc was purchased for a premium meaning the price of 105 was higher than its face value of 100 to be paid at maturity at the onset the bond might be considered negative yielding or a loss for the investor however we must include the bond s coupon rate of 5 per year or 5 to the investor so although the investor paid an extra 5 for the bond initially the 20 in coupon payments 5 per year for four years create a 15 net profit or a positive yield bond xyz has the following financial attributes bond xyz was also purchased for a premium meaning the price of 106 was higher than its face value of 100 to be paid at maturity however the bond s coupon rate of 0 per year makes the bond negative yielding in other words if investors hold the bond until maturity they ll lose 6 106 100 the 6 loss translates to a 6 loss in percentage terms and when spread out over the four years it equates to a negative yield of 1 5 6 4 years annually 