odysseus2000 wrote:Sticking to the bond in question, it has a coupon of 4.75 and trades at 145.45.
Over 10 years the bond pays out to the owner 4.75x10 =47.5 and at the end of 10 years it is bought back for par of 100. The cost to the issuer is therefore 100+47.5 =147.50.
Assuming no frictional costs then the Treasury could buy the bond now for 145.45 with a minimal saving of 147.5 - 145.45 = 2.05.
If a new bond at the equivalent of the US yield was launched at a coupon of 0.63, then over 10 years it would cost 0.63x10 =6.30.
Hence at current levels buying back the bond would incur an additional cost after 10 years of 6.30-2.05 = 4.25.
I was making the point that to have retired the bond earlier when it was much cheaper would have saved on the coupon payments.
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In the current regime of low interest rates a lot of high coupon debt issued by corporations has been bought back and replace with lower coupon debt to save company cash which is the point I was making about re-financing.
Regards,
And as you have just demonstrated buying back the bonds at a premium to par involves a (huge in this case) cost that needs to be funded. There is no free lunch in bond refinancing.
Refinancing takes place, and usually involves fresh capital, and different capital instruments, and often extending the duration of the debt. You won't get situations where you re-finance like-for-like and get a saving.
In your above example there is no need to issue the replacement with a 0.63% coupon. There was a 10 year Gilt issued last week, just above par, with a 0.375% coupon, as was already pointed out to you. That reduces your calculated "additional cost".
In going back to the "original question". 10 year government bond yields can be thought of as the "average" rate short term government debt is likely to be over the path of that 10 years. In the same way you might invest in a 1 month savings account and roll over 120 times, or (if available) invest in a 10 year fixed rate account. In addition, because the future is uncertain, tying up your money for 10 years is risky. Lots could happen. You would probably demand a "premium" to do so. Even the US government requires a premium in its term structure. You also want a small credit premium, as they might go bankrupt, and be able to repay (although this is tiny in the case of the US - especially in their own currency). A larger one would be demanded for others, such as Greece/Argentina etc. Then they will be a liquidity premium, which again is tiny as both US and UK bonds trade freely, with minimal cost and only extremely. rarely is it difficult or illiquid to trade.
This "term structure" applies to all maturities along the curve, which in the case of the UK is 50+ years, the US closer to 30.
10 year US trades > 10 year UK at the moment, some of which is because the short term rate is marginally higher Fed Funds are up to 0.25%, against UK Base Rate at 0.1%. More is due to expectations that the path of this short rate in the US will rise earlier, and further, than its UK equivalent.