TL/DR: looked everywhere, no straight answer to the following:
If a bond costs £100 initially with £5 return for 10 years, it will fully return £150 after 10 years. (Wild example, I know)
Would someone at any point pay over £150 (or over how much it currently has left)?
If so, why?
In: Economics
The main reason that someone would pay over is if it is a government bond and they are more concerned about the money still being there at maturity.
UK/US are very unlikely to ever default, but private banks can and do go bust. For £150 that isn’t a problem as there is deposit insurance.
If you multiply the numbers by a million it starts to make sense.
Otherwise, the bond will be priced according to its remaining interest compared to market conditions, becoming cheaper when rates rise and vice versa.
Assuming a rational person? no, because you’re better off putting your $151 into a bank than buying this bond.
But, it may be that somebody would pay $105 for it. And, it may be that the holder of that bond would sell it for $95.
Why? Because the bond represents future payments. If interest rates rise from 5% to, say, 8% overnight, then I could invest less than $100 to get the same future payments. And, if interest rates fall from 5% to, say, 2% overnight, then I would need to invest more than $100 to get the same future payments. The bond is just worth the present value of those future payments.
(Apologies for switching to $ from £. I don’t have a UK keyboard and didn’t want to do that much cutting-and-pasting.)
It would be unusual, but conceivably.
Imagine a situation where interest rates were so low that you could get no meaningful return on any investments.
You could keep your money under your bed, but they you run the risk of it being stolen.
In the event that the bond-issuer was extremely reliable, it might still be worthwhile to lose a small amount of money on your investment in return for security,
Some might respond by saying “why not put the money in the bank instead”, but what if the bank doesn’t pay interest and instead charges an account fee? In this case it would be a similar situation, where it would still be potentially in the investors best interest to pay for security
Never more than £150, unless there is something odd going on (for example, a tax break or some inflation protection).
Simplify it a bit. What is £100 worth to you right now? Obviously, exactly £100. A bond, though, is a promise for *someone* to pay an amount *in the future*: those two factors both reduce the value.
Now, what is £100 *one year from now* worth? Basically that’s the same question as “what do you think inflation will be over the next year?” – maybe about 3%, so say £97.
Now we look at the issuer. If it’s a Western government, we treat it as virtually certain to be paid: the US or UK government isn’t going to go bankrupt – a year from now, their bonds *will* be paid. (Apart from anything else, as governments with their own currency, they can literally just print a new £100 or $100 and hand it to you – bond paid.) So apart from inflation, we can trust them: on July 1st 2025, a bond saying “the UK government will pay you £100 on July 1st 2025” really will be worth the full £100 – so it’s worth about £97 now, if that’s the expected rate of inflation.
What if it’s a company though? Obviously not quite as solid a guarantee as a government: Tesco can’t just print £100 as needed, but they’re pretty solid – maybe 99% sure? So, if a government bond paying £100 in a year is worth £97 now, maybe that bond from Tesco would be worth more like £96.
Lower down the scale, say your local burger van needs new equipment, and finances it by selling bonds: in a year, they’ll pay you £100 – if they’re still going. That might be more like a 50-50 bet – so their promise to pay £100 in a year might only be worth £48 right now. If desperate, the burger van owner might actually try printing his own £100, and that’s part of the problem: he won’t be selling any burgers if he gets caught, and then your bond is worthless!
Which is why credit ratings exist, and why it’s a big deal for a company or country to have their rating downgraded: a country with a top credit rating will pay less to borrow today than a country with a lower rating will.
It depends on the bond. Everyone gets excited about the stock market but it’s tiny compared to the bond market. There are many, many different bonds that all serve different purposes. If you can tell me what bond you are looking at I can answer your question. (I trade bonds professionally).
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