1) April 26th, 2020

Why can the rate of a global bond be lower despite the increased risk?

Usually in finance, the relationship between risk and yield to maturity (ytm) is positive. In other words, a greater perceived risk in the economy must cause a higher rate required by investors. However, despite the fact that the coronavirus was increasing the risk in the economy, it is observed that the ytm of the Global Bond Peru 2050 (issued in dollars) decreased from 3.25% in December 2019 to 3.20% on March 13, 2020.

This fact can be explained through the decomposition of the ytm into two components: the ytm of the United States Treasury (of the respective term) and the risk spread. This spread is useful to quantify the risk of the bond of a certain country and term.

1. The first component, the 30-year US Treasury ytm, decreased (from 2.40% on December 31, 2019 to 1.58% on March 13, 2020). This decrease was caused by the reduction of the reference range of the federal funds rate in the United States and by the demand of investors looking for safe assets.

2. The second component, the risk differential, increased (from 0.85% on December 31, 2019 to 1.62% on March 13, 2020). This spread increased due to the higher perception of risk because of the coronavirus.

In net terms, the effect of the reduction in the ytm of the United States Treasury (first component) was greater than the effect of the increase in the risk spread due to uncertainty. Given this, it is concluded that, although the perceived risk increased, this was not the predominant factor.

This description can be expanded through the decomposition of the risk premium, analysis of comparable countries, study of the risk premium of bonds of other terms, ...