Greek Debt: Being Given Away And Still Overpriced? [View article]
skiman - - -
My logic is simple but my explanation in the article may not be.
I am comparing the Greek bond to the comparable German bond. In the case of the two-year instruments, the German rate is negligible (0.43%) compared to the Greek rate (~45%) so the risk free interest rate was ignored in the back-of-the envelope calculation.
What follows may be more detailed than you need. If so, I apologize in advance.
When we come to the ten-year case, the German yield is around 1.8% and the Greek yield around 18% (that was on Friday, today over 19.5% last time I checked). Let’s take a hypothetical Greek ten-year auction at Friday’s yield. That means the implied return at maturity is principal plus 180% (ignoring compounding / reinvestment effects).
If no principal is repaid then 100% of the 180% can be applied to recovering principal and the remaining accumulated coupon payments are now 80%. (The spread to the 10-year bund accumulates to about 62% over ten years.) The two investments end up equivalent if the two ultimately return the same amount. That means that to recover 1,180 euro accumulated by the bund including return of principal, the Greek bond uses the first 1,000 euro to replace principal and the next 180 is the first year coupon. Any of the remaining 9 years of payments are in excess of the break even vs. the bund and can be considered a risk premium on a defaulting Greek bond investment (total principal default).
The assessment of the market price in this case is that if Greek 10-years default on principal completely, the most probable case the market is pricing (dividing line between making money and losing money vs. the bund) is for about 90% of the coupon payments to also be forfeited.
What if the ultimate haircut on principal is 50%? Then the accumulated 1,800 euro (for 1,000 face value and investment) is applied 500 euro to replace lost principal and 1,300 euro for interest payments. This means that the Greek bonds will exceed the return of the equivalent bund by 1,120 euro (1,300 – 180) if all coupons are paid. Equivalence of return is achieved when 3.8 years of Greek coupons are received (500 principal payment + 500 replaced principal from coupon payments + 180 additional coupons). The needed coupon payments to reach equivalence is 680 euro. That is 680 / 180 = 3.8 years of coupon payments. Payment of any of the additional 6.2 years of coupons is the risk premium for a 50% haircut.
If the market has priced the Greek 10-year correctly at Friday’s yield, the haircut for exact equivalence to the bund is 62% for the Greek bond. That is the reduction of principal repaid at maturity if all 10 years of coupons are paid at 18%. The math: 1,800 - 1,180 = 620, the amount applied to replace haircut.
Again I’ll repeat that these are back of the envelope numbers and will be modified if reinvestment/compounding are included.
Thoughts on G20 Given the So-Called Currency War [View article]
Edward - - -
Excellent article. The global reach of U.S. QE may be its biggest problem. Steve Hansen has been writing about QE2 leakage over the past week. Interesting stuff.
You have in your article:
<<<-Brazil: “The last time there was a series of competitive devaluations. . . it ended in world war two.”>>>
That reminds me of a statement from "Did France Cause the Great Depression?" (econintersect.com/word...), quoting Robert Mundell:
<<< “Had the price of gold been raised in the late 1920’s, or, alternatively, had the major central banks pursued policies of price stability instead of adhering to the gold standard, there would have been no Great Depression, no Nazi revolution, and no World War II.”>>>
It has often been stated that wars are territorial. However, could it be even more so that wars are monetary?
The Center Cannot Hold; Be Wary of Being Long Only [View article]
John - - -
We are damned if we do and damned if we don't.
Do or don't what? Just about anything.
If we cut income taxes we encourage the extraction of as much cash as fast as possible from the economy.
If we raise income taxes we throttle back the potential for private investment.
If we tax income and don't tax capital gains, what would have been taken as income is converted by every trick available into capital gains and tax revenues fall.
If we cut all taxes the emphasis on short-term gains at the potential expense of the future is encouraged.
If we raise all taxes income and gains are manipulated to defer recognition and tax revenues are insufficient.
The bottom line is that trying to manage the economy with tax policy is fraught with all sorts of adverse consequences. The best thing to do is to arrive at a taxation policy that remains stable for a long time so that short-term manipulation of income and investment for tax advantage is removed from the equation and people (and companies) have a more rational stable base of operation, at least from the point of view of taxation.
This (stable tax policy) is unlikely because we have a system operated by people that are so clever that they can always think of a new "improvement".
Greek Debt: Being Given Away And Still Overpriced? [View article]
My logic is simple but my explanation in the article may not be.
I am comparing the Greek bond to the comparable German bond. In the case of the two-year instruments, the German rate is negligible (0.43%) compared to the Greek rate (~45%) so the risk free interest rate was ignored in the back-of-the envelope calculation.
What follows may be more detailed than you need. If so, I apologize in advance.
When we come to the ten-year case, the German yield is around 1.8% and the Greek yield around 18% (that was on Friday, today over 19.5% last time I checked). Let’s take a hypothetical Greek ten-year auction at Friday’s yield. That means the implied return at maturity is principal plus 180% (ignoring compounding / reinvestment effects).
If no principal is repaid then 100% of the 180% can be applied to recovering principal and the remaining accumulated coupon payments are now 80%. (The spread to the 10-year bund accumulates to about 62% over ten years.) The two investments end up equivalent if the two ultimately return the same amount. That means that to recover 1,180 euro accumulated by the bund including return of principal, the Greek bond uses the first 1,000 euro to replace principal and the next 180 is the first year coupon. Any of the remaining 9 years of payments are in excess of the break even vs. the bund and can be considered a risk premium on a defaulting Greek bond investment (total principal default).
The assessment of the market price in this case is that if Greek 10-years default on principal completely, the most probable case the market is pricing (dividing line between making money and losing money vs. the bund) is for about 90% of the coupon payments to also be forfeited.
What if the ultimate haircut on principal is 50%? Then the accumulated 1,800 euro (for 1,000 face value and investment) is applied 500 euro to replace lost principal and 1,300 euro for interest payments. This means that the Greek bonds will exceed the return of the equivalent bund by 1,120 euro (1,300 – 180) if all coupons are paid. Equivalence of return is achieved when 3.8 years of Greek coupons are received (500 principal payment + 500 replaced principal from coupon payments + 180 additional coupons). The needed coupon payments to reach equivalence is 680 euro. That is 680 / 180 = 3.8 years of coupon payments. Payment of any of the additional 6.2 years of coupons is the risk premium for a 50% haircut.
If the market has priced the Greek 10-year correctly at Friday’s yield, the haircut for exact equivalence to the bund is 62% for the Greek bond. That is the reduction of principal repaid at maturity if all 10 years of coupons are paid at 18%. The math: 1,800 - 1,180 = 620, the amount applied to replace haircut.
Again I’ll repeat that these are back of the envelope numbers and will be modified if reinvestment/compounding are included.
Thoughts on G20 Given the So-Called Currency War [View article]
Excellent article. The global reach of U.S. QE may be its biggest problem. Steve Hansen has been writing about QE2 leakage over the past week. Interesting stuff.
You have in your article:
<<<-Brazil: “The last time there was a series of competitive devaluations. . . it ended in world war two.”>>>
That reminds me of a statement from "Did France Cause the Great Depression?" (econintersect.com/word...), quoting Robert Mundell:
<<< “Had the price of gold been raised in the late 1920’s, or, alternatively, had the major central banks pursued policies of price stability instead of adhering to the gold standard, there would have been no Great Depression, no Nazi revolution, and no World War II.”>>>
It has often been stated that wars are territorial. However, could it be even more so that wars are monetary?
Top 5 Economic Graphs of the Week [View article]
Your second graph provides a unique view of the GDP numbers. I have not seen anything like this.
I would change your title to "The Top Economic Graph of the Week" with a sub-title "And Four Also Rans".
Excellent job of presenting data everyone talks about (GDP) in a way that few have viewed it.
The Center Cannot Hold; Be Wary of Being Long Only [View article]
We are damned if we do and damned if we don't.
Do or don't what? Just about anything.
If we cut income taxes we encourage the extraction of as much cash as fast as possible from the economy.
If we raise income taxes we throttle back the potential for private investment.
If we tax income and don't tax capital gains, what would have been taken as income is converted by every trick available into capital gains and tax revenues fall.
If we cut all taxes the emphasis on short-term gains at the potential expense of the future is encouraged.
If we raise all taxes income and gains are manipulated to defer recognition and tax revenues are insufficient.
The bottom line is that trying to manage the economy with tax policy is fraught with all sorts of adverse consequences. The best thing to do is to arrive at a taxation policy that remains stable for a long time so that short-term manipulation of income and investment for tax advantage is removed from the equation and people (and companies) have a more rational stable base of operation, at least from the point of view of taxation.
This (stable tax policy) is unlikely because we have a system operated by people that are so clever that they can always think of a new "improvement".
The Center Cannot Hold; Be Wary of Being Long Only [View article]
Why don't you look at what happened with employment just before the last recession started?
2007-09-01 508
2007-10-01 -308
2007-11-01 598
Official start of the recession was 12/2007.
Employment numbers may or may not give a clue about when a recession is starting.