Finance people…chime in!

[davelj]

bsrsharma, tomorrow morning you can buy many billions of dollars worth of 3-month treasury bills yielding 5.04%, all backed by the US Treasury. How’s that for preservation of principal and practicality? For that matter, if you just love the yen you can purchase many billions of dollars of 6-month Japanese bills yielding 0.76% backed by the Japanese Treasury. That’s just 74-ish basis points less than the 5 year is yielding. Who in their right mind would trade 74 basis points for 4.5 years in maturity (and its attendant duration) risk?

Again, I reiterate… buying an asset – even one backed by the taxing authority of an industrial nation (such as Japan) – that yields 1.5% with a maturity of 5 years is just plain nutso… and even more so when you can get 0.76% investing for just 6 months. Blips for Nips…

[davelj]

bsrsharma, tomorrow morning you can buy many billions of dollars worth of 3-month treasury bills yielding 5.04%, all backed by the US Treasury. How’s that for preservation of principal and practicality? For that matter, if you just love the yen you can purchase many billions of dollars of 6-month Japanese bills yielding 0.76% backed by the Japanese Treasury. That’s just 74-ish basis points less than the 5 year is yielding. Who in their right mind would trade 74 basis points for 4.5 years in maturity (and its attendant duration) risk?

Again, I reiterate… buying an asset – even one backed by the taxing authority of an industrial nation (such as Japan) – that yields 1.5% with a maturity of 5 years is just plain nutso… and even more so when you can get 0.76% investing for just 6 months. Blips for Nips…

[Coronita]

Before getting all excited about that 5% yield, remember, anyone investing in billions of $ (like Central Banks) want absolute certainty that their PRINCIPAL is safe and secure! That Emigrant Direct savings account is only insured up to $100,000 by FDIC. Anything beyond that can just "emigrate away" if the bank goes belly up! And you need a really big mattress to put a billion $ in Ben Franklins under it. So it boils down to currency risk diversification, preservation of principal and practicality.

 

Yes, that's per account. So open a couple… But if you think about it, what guarentee does a bond "really" have that is sooo much safer than the FDIC if  we have a financial crisis? The only "safe" thing at that time is to have precious metals (albeit expensive now.) Safety of an investment is just an illusion. It assumes theres no financial crisis. As such, I'm really not sure why folks want to put a majority of things into low yielding, "safe" things. If there is a meltdown, it doesn't really matter.

[Coronita]

Before getting all excited about that 5% yield, remember, anyone investing in billions of $ (like Central Banks) want absolute certainty that their PRINCIPAL is safe and secure! That Emigrant Direct savings account is only insured up to $100,000 by FDIC. Anything beyond that can just "emigrate away" if the bank goes belly up! And you need a really big mattress to put a billion $ in Ben Franklins under it. So it boils down to currency risk diversification, preservation of principal and practicality.

 

Yes, that's per account. So open a couple… But if you think about it, what guarentee does a bond "really" have that is sooo much safer than the FDIC if  we have a financial crisis? The only "safe" thing at that time is to have precious metals (albeit expensive now.) Safety of an investment is just an illusion. It assumes theres no financial crisis. As such, I'm really not sure why folks want to put a majority of things into low yielding, "safe" things. If there is a meltdown, it doesn't really matter.

[GoUSC]

Well technically a government would never default on their T-Bills. They will just print more dollars to pay them off. Of course that dollar would be worth nothing at that point.

[GoUSC]

Well technically a government would never default on their T-Bills. They will just print more dollars to pay them off. Of course that dollar would be worth nothing at that point.

[stansd]

First, most of the posts here reflect the general consensus tht the rate discprepancy makes no sense…that’s been the impetus of the “carry trade” where you borrow in Yen at a low interest rate and invest in T-Bills at a higher rate…it’s like printing money as long as the currencies don’t move against you.

In response, thought to the idea that this is insane, and at the risk of getting overly technical, investment banking models are currently viewing the yen as the most undervalued of all currencies worldwide. If you believe that to be true, you stand a big risk that the yen value that you have to repay is much higher than what you borrowed, which would mitigate your gain.

Simple example…Lets say you borrow 100 U.S. dollars in yen at a 130yen/$ exchange rate (you borrowed 13,000 yen). The interest rate on your loan is 1%. You then took that $100 and invested in T-Bills at 5%. In a years time, you have $105. Now it’s time to repay your loan. If all goes well, and the currencies don’t move, you made $4 ($5 interest made, $1 in interest paid). But, lets say the yen appreciates 10% to 117. You then have to repay 13,000/117 = $111 plus a little over a dollar in interest = $112. So, you just lost $7 ($112-$105) instead of making $4.

Don’t assume the market is being irrational just because it seems so on the surface. There are a lot of folks out there taking big, big risks, but making $100 a day for 2 years is nothing when you lose $1,000,000 in a day due to a big move in the currency (read fooled by randomness if you want to learn more).

Stan

[stansd]

First, most of the posts here reflect the general consensus tht the rate discprepancy makes no sense…that’s been the impetus of the “carry trade” where you borrow in Yen at a low interest rate and invest in T-Bills at a higher rate…it’s like printing money as long as the currencies don’t move against you.

In response, thought to the idea that this is insane, and at the risk of getting overly technical, investment banking models are currently viewing the yen as the most undervalued of all currencies worldwide. If you believe that to be true, you stand a big risk that the yen value that you have to repay is much higher than what you borrowed, which would mitigate your gain.

Simple example…Lets say you borrow 100 U.S. dollars in yen at a 130yen/$ exchange rate (you borrowed 13,000 yen). The interest rate on your loan is 1%. You then took that $100 and invested in T-Bills at 5%. In a years time, you have $105. Now it’s time to repay your loan. If all goes well, and the currencies don’t move, you made $4 ($5 interest made, $1 in interest paid). But, lets say the yen appreciates 10% to 117. You then have to repay 13,000/117 = $111 plus a little over a dollar in interest = $112. So, you just lost $7 ($112-$105) instead of making $4.

Don’t assume the market is being irrational just because it seems so on the surface. There are a lot of folks out there taking big, big risks, but making $100 a day for 2 years is nothing when you lose $1,000,000 in a day due to a big move in the currency (read fooled by randomness if you want to learn more).

Stan

[davelj]

Stan, your post offers a blinding glimpse of the obvious while completely missing my point altogether despite my attempts to articulate my point in the simplest terms possible.

Your post can be summed up as follows: If you’re engaging in the yen carry trade you might want to be long some yen in case it increases in value vis-a-vis the dollar. There’s nothing “overly technical” about that I can assure you; I think we can all follow you on that one.

My point – again – was that this is not a yen issue, per se, but a relative yield issue between the short and long ends of the curve and the relative risks incurred. As I stated in my last post, if you have some reason to be long the yen then just buy the currency or some short-maturity bill. But, for god’s sake, don’t buy that piece of 5-year paper yielding 1.5% because you’re just not getting compensated for the risk.

Perhaps you’d like to proffer a good reason for buying a 5-year piece of paper yielding 1.5% in any currency when the 6-month equivalent in that same currency is yielding 0.76%. Perhaps you believe that the long end will decline to 1% over a couple of years? If so, we can definitely do business.

(P.S. I’ve already read “Fooled by Randomness,” and while it’s a fine book – one of my favorites, in fact – I don’t see how it is any more relevant to this discussion than to any discussion on investing and humans’ various built-in behavioral biases, including the tendency to underestimate the probability of outliers.)

[davelj]

Stan, your post offers a blinding glimpse of the obvious while completely missing my point altogether despite my attempts to articulate my point in the simplest terms possible.

Your post can be summed up as follows: If you’re engaging in the yen carry trade you might want to be long some yen in case it increases in value vis-a-vis the dollar. There’s nothing “overly technical” about that I can assure you; I think we can all follow you on that one.

My point – again – was that this is not a yen issue, per se, but a relative yield issue between the short and long ends of the curve and the relative risks incurred. As I stated in my last post, if you have some reason to be long the yen then just buy the currency or some short-maturity bill. But, for god’s sake, don’t buy that piece of 5-year paper yielding 1.5% because you’re just not getting compensated for the risk.

Perhaps you’d like to proffer a good reason for buying a 5-year piece of paper yielding 1.5% in any currency when the 6-month equivalent in that same currency is yielding 0.76%. Perhaps you believe that the long end will decline to 1% over a couple of years? If so, we can definitely do business.

(P.S. I’ve already read “Fooled by Randomness,” and while it’s a fine book – one of my favorites, in fact – I don’t see how it is any more relevant to this discussion than to any discussion on investing and humans’ various built-in behavioral biases, including the tendency to underestimate the probability of outliers.)

[bsrsharma]

“Perhaps you’d like to proffer a good reason for buying a 5-year piece of paper yielding 1.5% in any currency when the 6-month equivalent in that same currency is yielding 0.76%”

One reason is there are institutions like insurance companies etc., that want to structure their maturities for constant cash flow. They are less keen on yield than on principal preservation. Think of a Japanese insurance company that simply wants a guaranteed one billion yen exactly five years from now, wants to take ZERO risk of any kind – investment or exchange rate – and DOESN’T care for return. What could it do? Put the cash in 5 year Japan treasuries and think of 1.5% return as gravy.

[bsrsharma]

“Perhaps you’d like to proffer a good reason for buying a 5-year piece of paper yielding 1.5% in any currency when the 6-month equivalent in that same currency is yielding 0.76%”

One reason is there are institutions like insurance companies etc., that want to structure their maturities for constant cash flow. They are less keen on yield than on principal preservation. Think of a Japanese insurance company that simply wants a guaranteed one billion yen exactly five years from now, wants to take ZERO risk of any kind – investment or exchange rate – and DOESN’T care for return. What could it do? Put the cash in 5 year Japan treasuries and think of 1.5% return as gravy.

[davelj]

bsrsharma, that’s actually a good answer, albeit with one attendant observation. While there probably are Japanese insurance companies that would buy that note for the very reason you stated, that 1.5% return would likely not be “gravy.” More specifically, like all insurance companies there’s a set of cash outflows that’s being matched up (in theory) with that inflow of 1.5%. My bet is that the insurance company isn’t making any net profit once the two are netted out. But the Nips are famous for tolerating break-even/unprofitable enterprises – look at their banks – so it wouldn’t surprise me one bit. But, you’re right in that Japanese insurance companies are probably one of the buyers, although certainly not the sole buyers. Personally if I were running an insurance company I’d rather capture a higher yield in a different currency and simultaneously hedge away the currency risk which should net a higher return (even after hedging costs) – but it is more risky, however minute.

[davelj]

bsrsharma, that’s actually a good answer, albeit with one attendant observation. While there probably are Japanese insurance companies that would buy that note for the very reason you stated, that 1.5% return would likely not be “gravy.” More specifically, like all insurance companies there’s a set of cash outflows that’s being matched up (in theory) with that inflow of 1.5%. My bet is that the insurance company isn’t making any net profit once the two are netted out. But the Nips are famous for tolerating break-even/unprofitable enterprises – look at their banks – so it wouldn’t surprise me one bit. But, you’re right in that Japanese insurance companies are probably one of the buyers, although certainly not the sole buyers. Personally if I were running an insurance company I’d rather capture a higher yield in a different currency and simultaneously hedge away the currency risk which should net a higher return (even after hedging costs) – but it is more risky, however minute.

[bsrsharma]

“My bet is that the insurance company isn’t making any net profit once the two are netted out. But the Nips are famous for tolerating break-even/unprofitable enterprises”

I think there is some confusion here. The insurance company wants to make profit in insurance business i.e. estimating cost of risk payout and charging premiums to cover that and profit. Buying treasuries is not any more interesting to them than you and me keeping a few hundred $ in checking/savings account. They have enough risk to manage in insurance business and would probably do a bad job if they try to manage money risk – that may blow up their insurance business if something goes wrong. Imagine getting hit with hurricane Andrew or Katrina in a down market – fast ticket to bankruptcy (and may be even to jail – for underwriting much more than loss reserve)

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