Bond market in germany


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Bond market in germany

  1. 1. -AKSHITA ALOK 768
  2. 2.  Governments borrow money by selling bonds to investors. A bond is an IOU. In return for the investor's cash, the government promises to pay a fixed rate of interest over a specific period - say 4% every year for 10 years. At the end of the period, the investor is repaid the cash they originally paid, cancelling that particular bit of government debt. Government bonds have traditionally been seen as ultra-safe long-term investments and are held by pension funds, insurance companies and banks, as well as private investors. They are a vital way for countries to raise funds.  Once a bond has been issued - and the government has the cash - the investor can hold the bond and collect the interest every year until it is repaid. But investors can also buy and sell bonds that have already been issued on the financial markets - just like buying and selling shares on the stock market.
  3. 3.  The price of the bond will fluctuate as the outlook for interest rates changes. So, for example, if the markets think that interest rates are going to rise sharply, then the value of a bond paying a fixed rate of 4% for the next 10 years will fall. Bond prices will also fall if investors think that there is a risk of the government that issued the bond not being able to make the annual interest payment or repay it in full on maturity - and these are the fears which have been pushing down Spanish bond prices.  The bond yield tells the investor what the return on their investment is, and can be calculated based on the current price of the bond in the market. If a 100-euro bond is paying 4% fixed interest - in other words, 4 euros per year - and the bond can be bought for 100 euros, then the yield is 4%.
  4. 4.  If the bond price falls to 90 euros, then the yield will rise. That's because the investor is still getting paid 4 euros every year, and 100 euros at maturity, which is a much bigger return compared with the 90 euros they must put down to buy the bond.  Because they determine what it costs a government to borrow. When a government wants to raise new money, it issues new bonds, and has to pay an interest rate on those bonds that is acceptable to the market. The yield at which the market is buying and selling a government's existing bonds gives a good indication of how much interest the government would have to pay if it wanted to issue new bonds.
  5. 5.  German bonds are known as Bunds (from Bundesanleihen). Bund maturities range from four to thirty years. Other bonds, such as five year federal notes “Bobls” (from Bundesobligationen); two year maturity federal Treasury notes “Schatze” and Federal savings notes (Bundesschatzbriefe) are also purchasable by individuals. Inflation-linked German Government Bonds have been added recently to bond market offerings. In German bonds, the practice is to treat each month of the year as having 30 days for purposes of calculating accrued interest. There are various tax provisions related to German bonds, including a withholding tax on interest for most investors.
  6. 6.  The German Government Bond issuance is considered a “gold standard” or benchmark in Europe (even after the creation of the Euro). In Germany, the bond market for individual investors is not significantly “direct”, that is, although the individual investor in Germany has significant amounts of bonds in his/her overall asset holdings, most of the activity is not by purchasing individual bonds but rather by holding bonds through mutual funds and in “insurance” products, i.e. pension and retirement funds, burial funds, etc.
  7. 7.  Bonds are about 2/3 of the total amount of securities outstanding in bonds and shares  About 60% of the German bond market is government bond debt, 29% is corporate, and 11% is asset-backed  Bond markets are open to both institutional and individual investors, but there is much more participation generally by institutional investors than individual investors. German individual investors in bonds represent less than 5% of the direct investment in the German bond markets. The majority of bond market participants in Germany are institutional investors, such as pension funds, insurance companies and banks.
  8. 8.  In Germany, individual investor holdings of bonds comprise between 10-15% (in 2004, some €5,800)  In Germany, individual investors prefer to invest in bonds directly while in other European countries such investments take place primarily through funds.
  9. 9. German Pfandbriefe were taken as a model in several European countries when legal frameworks were reformed in the late 1990s to enable the issuance by certain financial institutions of similar instruments secured on portfolios of mortgage loans. The high credit quality of mortgage Pfandbriefe, generally a triple-A rating from at least one rating agency, stems from some key features: first, a well-established regulatory framework, which was revised in July 2005 (see Appendix II for details); second, the quality of the collateral pool, which must be covered by related assets of at least an equal amount and yield; third, the high quality of the cover pool encompassing first ranking mortgages with LTV ratios no higher than 60 percent; and fourth, in case of the bankruptcy of the issuer, the privileged position of Pfandbriefe holders is guaranteed by a statutory preferential right and the separation of the cover pool (administered by an independent trustee).
  10. 10. There is an exception to this general positive trend. In September 2005, one of the main issuers of mortgage Pfandbriefe, Allgemeine Hypotekenbank Rheinboden (AHBR), was on the brink of bankruptcy. This was the result of a protracted period of financial difficulties on account of the mismanagement of its fixed income loan book. The markets reacted strongly to the critical situation of AHBR and the issuer was downgraded to non- investment grade (from single A). The spreads for its mortgage Pfandbriefe increased from nearly zero to about 15 basis points. After AHBR was taken over by a U.S. Financial investment company and following the announcement of the restructuring plans in January 2006, the spreads seem to have stabilized. It is worth noting that while AHBR’s rating was severely downgraded, its covered bonds remained highly rated (AA-AAA) throughout this process.
  11. 11.  Ten and thirty-year Bunds represent the long end of the German Government yield curve. At year-end 2012 they account for about 60% of the Federal Government’s debt portfolio. In 2012 ten-year Bunds comprised again 22 % and thirty-year Bunds about 3% of the annual issuance volume.  In 2013 three new ten-year Bunds with maturities in February, May and August 2023 and a volume of € 5 billion will be issued for the first time. Each one will be reopened three times with volumes of € 5 billion and thereafter two times of € 4 billion. At year-end all three issued Bunds will reach a total outstanding volume of € 18 billion respectively.
  12. 12.  In the secondary market for German Government securities Bunds accounted for a total share of over 50% of trading volume and for over 10% of the net volume, based on the absolute positions (purchases less sales) of reporting member banks of the Bund Issues Auction Group. Since many years ten-year Bunds are the flagship product at the secondary level of the German Government bond market.  Characteristics: Redemption at par; interest calculated on an actual/365 or actual/366 basis; not redeemable prematurely and not callable by the issuer. Since on January 1st, 2013 new issuance terms and conditions came into effect Federal bonds imply new standardised maturity dates on February 15th, May 15th, and/or August 15th.