How Ultra Long Term Bonds Work?
In September 2018, Austria became the latest developed country to issue ultra-long-term bonds. As per the deal, Austria raised a total of $4.2 billion which have to be paid back after 100 years! The interest rates on this bond were 2.11%. This deal is being called the largest ever issue of bonds which have a hundred-year maturity. This is not the first time Austria has tried its luck selling ultra-long-term bonds. In 2016, it issued 70-year bonds which were quickly snapped up by investors. The issuance of these ultra-long-term bonds has given Austria a competitive edge. Most other Eurozone countries are struggling with rising yields. However, Austria has been able to lock funds which it can over the long term and on which it has to pay very little interest.
Austria is not the only country which is experimenting with ultra-long term debt. These types of debt instruments have caught the fancy of other nations such as Ireland and Belgium. However, the scale of their debt issuance was very small. Austria has issued ultra-long term debt worth $4 billion. On the other hand, Ireland and Belgium have made a combined issuance of a mere $100 million. Also, these bonds were only sold via private placement and not listed on any exchange for trading.
Apart from European countries, Argentina has also shown a keen interest in issuing ultra-long term debt. In the year 2017, Argentina also issued $2.75 billion in century bonds. The only difference is that Austria had to pay only 2% in interest, whereas Argentina has been forced to pay 8% per annum. Hence, it would be appropriate to say that the success of the Austrian bond issue has more to do with the stellar reputation of Austria as a borrower, rather than the functionality of century bonds in general. Austria has never defaulted on its debt. On the other hand, Argentina has defaulted at least once in every 25 years since its inception.
Over the years, the ultra-long bonds have become extremely popular. Developing countries like Nigeria and Argentina have also successfully issued these bonds. IN 2018, the total amount of ultra-term bonds exceeded $75 billion.
Who Buys these Ultra-Long Term Bonds and why?
Pension funds and insurance companies are the most obvious borrowers for ultra-long-term bonds. This is because these are the companies that have ultra-long term liabilities. Hence, even if they buy century bonds i.e. ultra-long term assets, the liquidity position of their balance sheet is not disturbed. The problem is that the number of pension funds itself is shrinking. This is largely driven by the fact that pension programmes have now changed from defined benefit plans to defined contribution plans.
Pension funds generally prefer ultra-long-term bonds because the yields on these bonds are higher than the normal bonds issued by the same government. As a result, the funds can make a better return on these bonds. They do not intend to hold it until maturity. This is the reason why funds buy bonds from countries like Argentina even though historical data makes it clear that Argentina is very likely to default over a 100 year period.
The Austrian bond sale caught the fancy of the American Treasury Secretary Steve Mnuchin. It is said that America is considering selling these ultra-long-term bonds. However, their researches have shown that there is no unmet demand for ultra-long-term securities. There are very few investors who put their money in this asset class, and these investors have too many options.
The Americans have come to a conclusion that beyond 30 years, investors do not view a longer maturity period more favorably. This is because there isnt too much liquidity for these century bonds. Hence, investors find it difficult to offload these bonds and convert them into cash during a selloff.
Why does America want to Issue these Bonds?
Despite the negative feedback about these bonds, it is highly likely that the American government will issue them in the near future. This is because America wants to rebuild its infrastructure and is looking at almost a $1 trillion bill!
The problem is that infrastructure assets like bridges, ports, etc take a very long time to break even. Hence, if the government finances long term assets with short term debt, it could find itself in a tight spot. Century bonds will be the perfect instrument for the United States government to raise debt. It will allow them to match the cash flow from the assets to the cash flow promised to bondholders. The interference required by the American government will be minimal in this case.
Also, if America has to issue century bonds, this might be the best time. It is true that the Federal Reserve has raised interest rates four times in 2018. It is also true that the Fed intends to continue doing so in the future. The higher interest rates are likely to stay for some time. This is the reason why America would be better off if it locked the historically low-interest rate right away. The more the issuance of these bonds is delayed, the higher the interest rate is likely to be.
The bottom line is that ultra-long-term bonds are still a very small niche. Many countries have got interested in this niche, and they are likely to flood the market in the long term.
|❮❮ Previous||Next ❯❯|
Authorship/Referencing - About the Author(s)
The article is Written By Prachi Juneja and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
- Introduction to Forex Markets
- History of the Forex Market
- Bretton Woods Agreement and Smithsonian Agreement
- Currency Pegs
- Common Terminologies Used in Forex Markets
- Forex Trading vs. Regular Trading
- Understanding the Trading Cycles in Forex Market
- How Are Exchange Rates Determined ?
- Types of Quotations in Forex Market
- Types of Orders in the Forex Market
- Advantages and Disadvantages of Forex Market
- The Importance of Forex Education
- Major Currency Pairs
- Types of Market Participants
- Types of Intervention by Central Banks
- Dollar Yuan Peg
- Forex and Labor Arbitrage
- Carry Trade and Rollovers
- Special Drawing Rights (SDRs)
- Interest Rates and Forex Market
- Exorbitant Privilege: US Dollar
- Freely Floating Exchange Rates
- Argentina Financial Collapse
- Asian Financial Crisis of 1997
- Currency Wars
- Freely Falling Currencies
- Black Wednesday of 1992: The Day the Pound Sterling Came Under Attack
- Russian Ruble Crisis of 1998
- The Mexican Currency Crisis (Tequila Crisis) of 1994
- The South Sea Bubble
- Tulip Mania of the 17th Century
- Spanish Property Bubble of 2008
- Poseidon Bubble in the Australian Stock Market
- Bernie Madoff Scandal
- The Dot Com Bubble of 2001
- The Harshad Mehta Scam in India (1992)
- The Ketan Parekh Scam
- Savings and Loan Crisis in the United States (1980s)
- The Failure of Long Term Capital Management (LTCM)
- The Albanian Revolution and Pyramid Schemes
- Puerto Rico: The Greece within America
- Israel Economic Crisis: 1983
- The Nordic Crisis of 1992
- The Historic Iceland Crisis of 2009
- The Latvian Crisis: A Short History
- John Law and the Mississippi Bubble
- Brexit after Effects: British Economy Beats Slowdown Fears
- The End of the Dollar Hegemony
- Why Devaluing the Currency is a Bad Idea ?
- What is Causing the Bitcoin Boom?
- The Big Fat Bitcoin Bubble
- Gold vs. Bitcoin
- The Problem with Having Bitcoin Futures
- The Problem with Venezuelan Cryptocurrency
- Traditional Bonds vs. Islamic Bonds Called Sukuk
- How Decisions Made By Central Banks Affect the Stock Market?
- How to Leave the Euro?
- Are We In A Stock Market Bubble?
- Why Does the Stock Market Crash?
- Hard Brexit vs. Soft Brexit
- What is Blockchain, Why is it so Popular, and Benefits and Challenges of Using it
- Cryptocurrencies and Taxation
- Is this the Longest Bull Market in History?
- Investing in Unlisted Companies
- Why Is Short Selling A Dangerous Financial Strategy?
- Development Impact Bonds
- How Credit Enhancement Works?
- How Ultra Long Term Bonds Work?
- How to Identify an Overvalued Market?
- How do Companies Choose which Exchange to List on?
- The FAANG Sell-off
- Why are Investors Getting Spooked by an Inverted Yield Curve?
- Catastrophe Bonds
- The NSE Co-Location Fraud
- The Economics of Blue Bonds
- How the GameStop Saga Proves That Shoe is on the Other Foot for the Investors
- 5 Principles of Forex Trading Systems
- 5 Reasons Why Fundamental Analysis Does Not Work In Forex?