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How much do you know about rates?

  • How much do you know about rates?

    Recognise the different terms related to interest rates and understand how much yield global government bonds can offer.

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  • Four essential keywords related to interest rates

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28 February 2022

1. How does the coupon rate differ from yield to maturity?

The coupon rate is the annual interest rate a bond issuer promises to pay bondholders. For instance, a fixed-rate bond pays a fixed coupon rate for the bond’s entire duration. However, the amount of interest received by bondholders each time depends on the principals, coupon rates, and coupon payment frequencies each year.

 

Yield to maturity (YTM) is the expected annualised return an investor would receive for holding the bond until maturity. The YTM calculation considers potential coupon income and bond price movements that reflect the actual rate of return.

 

Bond prices in secondary markets are affected by multiple factors that also impact YTM.

 

· If a bond is purchased at a price equal to its face value (i.e., at par), the YTM is the same as the coupon rate.

· If a bond is purchased at a higher price than its face value (i.e., at a premium), the YTM is lower than the coupon rate.

· If a bond is purchased at a lower price than its face value (i.e., at a discount), the YTM is higher than the coupon rate.

2. What is the risk-free rate?

The risk-free rate is the return from an investment made in a nearly zero-risk asset. The yield of the 10-year US Treasuries is regarded as a risk-free rate indicator because the US has a relatively high sovereign credit rating1, and the market generally believes the US government is unlikely to default on its debts.

 

Investors typically use the risk-free rate as a benchmark to evaluate the attractiveness of investment products with relatively low risk profiles. Theoretically, assets with a higher risk profile (such as those with lower credit ratings) or greater volatility (such as single market stocks) need to offer potentially greater returns than risk-free rates to attract investors.

3. How much yield do global government bonds offer?

The yields of global government bonds vary greatly due to a number of factors, including sovereign ratings, benchmark rates, and market demand. Not all sovereign bonds can maintain a positive yield. In several European nations, such as Germany, Switzerland, France, as well as Japan, the yields of government bonds with a maturity of five years or less are negative. On the contrary, the yields of Asia Pacific (ex-Japan) government bonds remain positive, with the yields of 10-year Indonesian and Indian government bonds surpassing 6%. 

1 Credit rating agencies Moody’s and Fitch have assigned the highest sovereign ratings of AAA and Aaa, respectively, to the US. Meanwhile, Standard & Poor’s has assigned its second highest rating of AA+ to the country. As of 30 November, 2021.

 

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    Read more
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