What Is Negative Bond Yield?
When investors buy bonds, they are lending money to the companies or governments that issue the bonds. In return, those bond issuers agree to pay investors interestthroughout thelifetime of the bond andto repay the bond's face valueuponmaturity.
The money that investors earn from interestand any profit from the repayment of principal is called yield. Usually, this yield is a positive figure. But it's possible for a bond yield to be negative. A negative bond yield means the investor would lose rather than make money on their bond investment.
Key Takeaways
- A negative bond yield means that an investor receives less income from the bond than they paid for it.
- A negative bond yield can result when the price paid for the bond is much greater than par.
- The yield-to-maturity calculation can be used to determine whether a bond yield will be positive or negative.
- The current yield calculation simply shows an investor the interest they'll receive based on the coupon rate income and the current price of a bond.
- Failing to reinvest all coupon income received could also negatively affect a bond's YTM.
Understanding Negative Bond Yield
If a bond has a negative yield, it means a bondholder loses money on their investment, although this is uncommon.
Whether a bond has a negative yield can be determined by a yield calculation. There are three yield types. They are the coupon yield, the current yield, and the yield-to-maturity (YTM). Each provides different information about income that flows from a bond investment.
Coupon Yield
Coupon yield is the annual rate of interest that's fixed for the life of a bond when the bond is issued. It's the interest rate paid by the bond, stated as a percentage of par.
For instance, you might see a bond with a coupon rate of 4 1/2% or 7%. A bond with a face value of $1000 and a coupon rate of 7% would pay an annual amount of interest of $70. No matter what happens to the price of the bond, as the investor, you'd receive this amount every year until the bond reaches maturity.
Current Yield
The current yieldof a bond determines the amount of interest paid annually relative to the current selling price in the secondary market. To calculate current yield, simply divide the annual coupon payment by the bond's selling price.
Let's take the above example of a $1,000 bond with a coupon rate of 7% that is currently selling for $700. The current yield would be 10% ($70 / $700 x 100).
Using this formula, it is nearly impossible for a bond to have a negative yield. Even if the current price is substantially above par, a bond that pays any interest at all will always havea positive current yield. For a bond to have a negative current yield, it has to pay negative interest.
Yield-To-Maturity
The yield-to-maturity (YTM) calculation is a more comprehensive yield formula that incorporates all income sources related to the bond. Those income sources are:
- Coupon payments
- Interest-on-interest (assuming you reinvest your coupon payments)
- The profit resulting from the par (or face) value that you receive at maturity minus what you paid for the bond
A bond's YTM, therefore, represents the estimated rate of return that an investor can expect if the bond is held until it matures and all coupon payments are reinvested at the YTM rate.
The bond has to generate a negative total return to have a negative yield. For the YTM to be negative, a bond has to sell for a price so far above par that all its future coupon payments, plus the compounding interest associated with those reinvested coupon payments, plus any profit that results when principal is redeemed could not outweigh the initial investment.
Some investors buy bonds with negative yields as a bet that interest rates will go lower and, as a result, the bond price will rise. They then sell the bonds at a profit.
Example of a Negative Bond Yield
Take the bond described above. It has a $1,000 face value and a coupon payment of $70. Let's say also that it has 5 years to maturity, and it was bought by an investor for $800. Given all those factors, its YTM is 12.64%.
However, what if an investor bought the bond at a premium to par (rather than at a discount), paying $1,650 instead of $800. Intuitively, an investor might think the YTM would be lower because they spent so much more money than they'll get back as principal ($1,650 vs. $1,000). They'd be right. The calculation shows that the YTM plummets to -4.354%.
Is a Negative Bond Yield Bad?
A negative bond yield means that an investor receives less from the bond than it cost to buy it. So, if you are simply buying a bond as an investment to make a profit, then, yes, a negative bond yield essentially is bad since it corresponds to a financial loss.
What Causes a Negative Bond Yield?
A negative bond yield results when the total amount of income that you receive from a bond investment is less than the price you paid to purchase the bond.
Is the Yield-To-Maturity Exactly What I Will Receive?
YTM is actually an estimate of what you can earn. Investors want to know this yield before they decide to purchase a bond. Whether they actually receive it depends on whether they always reinvest their coupon income at a rate equal to the YTM and hold the bond to maturity.
The Bottom Line
A negative bond yield means that the yield for an investor is less than zero. It indicates that, taking the factors of face value, annual coupon payment, years to maturity, and the purchase price of the bond into account, an investor will receive income from the bond investment that is less than the price they paid for it.
