Is this your source? Greenspan Has Taken the Horse to the Water
I thought Antal E. Fekete was a clown before, this proves it.
Let's use a simple example, you hold a 1 year bond with a coupon rate of 5%. The "market yield" on 1 year bonds is 5%. Your bond trades at par (priced at $1000).
You borrow Yen at 1% and buy the bond. If you hold until maturity, you'd earn $50 interest on the bond, owe $10 interest on your Yen loan and after converting your dollar proceeds back to Yen, net a $40 profit, assuming no transaction costs and no currency fluctuations.
The purpose of the exercise is to drive up the price of dollar-bonds to the unheard-of heights of yen-bonds. Note the double-whammy. In addition to the unearned income of 4 percent the speculator will pocket huge capital gains after bond prices appreciate.
In this example, there is no capital gain because you held to maturity. In Antal's world, buying drives up the price, allowing you to sell (without driving down the price) at a huge profit. Profiting from the yield disparity and the capital gain.
Better still, the rising yen turns the double-whammy into a triple-whammy. The falling dollar makes the terms of trade for the speculator improve.
Here's where he starts to lose it. You've borrowed Yen, let's say 100 Yen to the dollar, 100,000 Yen total, (and sold them to buy dollars) and now the Yen rises. Say the Yen rises 10%, 100 Yen buys $1.10. In my 1 year example, you've earned $50 interest on the bond, but now your $1050 proceeds only buys 95454.54 Yen to pay off the loan, 100,000 Yen plus 1,000 Yen interest. You still owe 5545.45 Yen. A loss of 5.545%.
True, he will have a loss on the short leg of the trade, namely, loss due to the rising exchange rate. In percentage terms this loss is in the order of one-digit.
Yeah, 5.545% is only one digit.
But profits on the long leg, the portfolio of dollar-bonds, are in the order of triple-digit. With these odds, why should he care about losses on the short leg?"
This is funny! Let's see how we can get triple digit profits on a long bond. Use my 1 year bond example, just for simplicity sake. 1 year bond, 5% coupon bought at par. So many "speculators" buy these bonds because "the FED telegraphs that they will ensure bond prices keep going up" that the yield drops to 1%, the same as the Yen borrow costs. If Antal believes the bond is now priced at $5000, making the $50 interest payment a 1% yield, that explains his "triple digit profit" theory. How does it work in the real world?
When the $1000 par bond matures, you get $1,000, plus your final interest payment, $25 (they pay twice a year). So, a 5% coupon bond in a 1% interest environment would not be priced at $5000, but closer to $1040. You'd "lose" the $40 premium over the next year and receive the $50 in interest to net $10, or 1% (forgive my slight rounding errors).
In my estimation, a $40 capital gain on the bond, assuming you sold after rates instantly dropped from 5% to 1%, gives you a 4% capital gain, not a triple digit capital gain.
Now, even assuming that rates drop from 5% to 1%, instantly, is a bond trader going to buy a 5% bond if the "real" inflation rate is 8.5%?
I apologize to everyone for the length of my post, my earlier, shorter posts were apparently too difficult to understand.
Absolutely!
A $100k 1-yr bond sells for $95k when rates are 5%. I buy it, the next day rates go to 1% and a $100k 1-yr bond is now worth $99k, which is what I sell my bond for, and I pocket a cool $4k. In one day I've picked up a 4% return, which translates to an annual rate of 166,504,861.4%. OK, after 8.5% inflation I'm only getting a 166,504,852.9% rate of return but hey, it's a living.
MB>BRAVO !</B>