0
$\begingroup$

I was reading this article which has this paragraph:

One concern for investors is that a rise in real yields would raise borrowing costs, increasing the debt burden of consumers and businesses. That could further crimp the prospects for economic growth, which could make major central banks cautious in shifting toward reduced monetary stimulus.

As I understand, yields(including real yields) are defined as $\frac{bond\ coupon}{bond\ value}$.

So, if real yields are increasing, then it means bond values are decreasing, so a company issuing a bond would get less money. But that doesn't stop the company from issuing more bonds.

So, why would borrowing costs rise?

$\endgroup$
5
$\begingroup$

Your formula is the definition of the running yield, which is a crude approximation. Let $P$ be the price of a zero-coupon bond paying 100 at maturity and $y$ its yield. Then it holds that $$ P = 100 \times \exp(- y T), $$ where $T$ is the maturity. If we set $y = i+r$, where $i$ is the inflation and $r$ is the real interest rate (similar to the Fisher equation) then this becomes: $$ P = 100 \times \exp(- (i + r) T), $$ thus the higher $r$ the less you get now and still have to pay 100 after $T$. This is how real rates make borrowing more expensive.

The same is true for coupon-bearing bonds.

$\endgroup$
3
$\begingroup$

Let's consider raising money (issuing 1 year zero coupon bond) under the following 2 scenarios (ceteris paribus):

  1. High yields (20%) -- you raise 80 USD and promise to return 100 USD at the end of the year. Your cost is 20 USD;
  2. Low yields (5%) -- you raise 95 USD and promise to return 100 USD at the end of the year. Your cost is 5 USD;
$\endgroup$
1
$\begingroup$

a company issuing a bond would get less money. But that doesn't stop the company from issuing more bonds.

No, but it increases the cost of borrowing. Suppose a company wants to sell bonds to raise \$1,000. If the amount a company can get for a new \$1,000 bond issue lowers from \$950 to \$900, then it has to either

  • issue more bonds in order to receive the same amount,
  • settle for less money received, or
  • raise the coupon rate of the bond issues.

All of those either directly increase costs (more interest paid) or reduce the benefit to the company, indirectly increasing costs.

$\endgroup$
1
$\begingroup$

One thing to keep in mind is that the majority of bonds are issued close to par. In a rising yield environment, for a coupon-paying bond to be priced at par yet to offer a higher yield, the coupon has to be higher. Effectively, your borrowing cost is higher.

$\endgroup$

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.