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Katchum
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Albert Sung is the author of Correlation Economics, monitoring breaking economic news on a day to day basis. He started investing in 2008 because of the economic crisis and holds a masters degree in chemical engineering. Previously, he worked several years as a process engineer at Ashland, a... More
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  • Case Study On Belgian Government Bonds And Why Low Bond Yields Are Unprofitable 0 comments
    Jul 14, 2012 7:23 AM

    A couple months ago, Belgium sold government bonds to the public. For example 10 year bonds at 5%. I'm living in Belgium, so I took this example. I've never really looked at how profits are being made by selling/buying government bonds. So let's analyze this a bit. This is just a note to myself.

    Let's take a 10 year Belgian government bond at 5% (Chart 1). Suppose I bought an amount of 1000 euro of these bonds. This means that after 10 years I get paid with: 1000 + 10*5%*1000 = 1500 euro.

    Indeed, after 10 years I made 50% profit on the principal. 1000 euro became 1500 euro.

    Chart 1: Belgium 10 Year Government Bonds

    What happens when 7 months later, bond yields go down to 2.65%, like today is the case (Chart 2).

    Chart 2: Belgium 10 Year Government Bonds

    Let's reperform the calculation. If I buy an amount of 1000 euro of these 10 year Belgian bonds. I get repaid with: 1000 + 10*2.65%*1000 = 1265 euro.

    So after ten years my 1000 euro becomes 1265 euro. That's a 26.5% profit in 10 years.

    Now comes the clue. If I sell my 10 year Belgian bonds (with 5% interest) on the market, as compared to the current rate of 10 year Belgian bonds today (with 2.65% interest), I will make profit.

    That profit is: 1500 - 1265 euro = 235 euro.

    How much percent profit is that? 235/1000 = 23.5%

    That's a pretty high profit if you ask me. Gold has been doing worse in those 7 months, it went up only 5% in euro terms.

    Now let's go a bit further. If the interest would be cut in half again from 2.65% to 1.25%, what will be my profit?

    1265 - 1125 euro = 140 euro

    My percentage profit = 140/1000 = 14%

    And when it gets cut in half again from 1.25% to 0.625%.

    1125 - 1062.5 = 62.5 euro

    My percentage profit = 62.5/1000 = 6.2%

    And when it gets cut in half again from 0.625% to 0.312%.

    1062.5 - 1031.2 = 31.3 euro

    My percentage profit = 31.3/1000 = 3.1%

    You see, the lower the interest rate is, the less profit you can make in proportion to the yield cut. I can't understand how people still want to buy these government bonds at these low yields.

    Talking about a bond "bubble"... it's staring right in your face:

    U.S. 10 year government bonds are now at 1.5%. If that yield were to go to 0%, you could make only 15% profit. Gold will ultimately go much higher than this 15%.

    Themes: Bonds
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