Yield Curve

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Jan 13, 2007 9:30 pm

What do you think of the bond market these days. Do you think the curve

will continue to flatten out? Whats everyones opinion?

Jan 13, 2007 9:38 pm

I have been exposed to a bunch of textbook stuff about long terms versus short term rates. We  know what is supposed to happen.


The thing I don't get is, who actually borrows money for more than ten years, anymore? Everyone, every company, every government wants to refinance (for various reasons) in shorter timeframes.


Are long term commitments to "lending" through bonds becoming less signficant, or are we just at the point in the cycle when we will see the significance? Obviously I am not a fixed income guru.


Jan 14, 2007 1:26 pm
planrcoach:

The thing I don't get is, who actually borrows
money for more than ten years, anymore? Everyone, every company, every
government wants to refinance (for various reasons) in shorter
timeframes.





Know anyone with a 30 year mortgage?




Jan 14, 2007 2:25 pm
planrcoach:

I have been exposed to a bunch of textbook stuff about long terms versus short term rates. We  know what is supposed to happen.


The thing I don't get is, who actually borrows money for more than ten years, anymore? Everyone, every company, every government wants to refinance (for various reasons) in shorter timeframes.


Are long term commitments to "lending" through bonds becoming less signficant, or are we just at the point in the cycle when we will see the significance? Obviously I am not a fixed income guru.




Taking a long view, it would seem to me to make sense for a reasonably profitable business to want to leverage up at today's long rates, essentially getting "permanent capital" at a cost of around 6-7%(or less depending upon their credit quality).  Of course, short term analysts will not like that, and short term it thus may hurt the stock, even though longer term it will give them more capital to deploy(if they have a place to put it profitably)

But that's generally the problem with today's environment....execs don't make decisions for the long term good of the business...they're too concerned about the short-term "beauty contest".

Jan 14, 2007 4:34 pm
joedabrkr:



Taking a long view, it would seem to me to make sense for a reasonably profitable business to want to leverage up at today's long rates, essentially getting "permanent capital" at a cost of around 6-7%(or less depending upon their credit quality).  Of course, short term analysts will not like that, and short term it thus may hurt the stock, even though longer term it will give them more capital to deploy(if they have a place to put it profitably)

But that's generally the problem with today's environment....execs don't make decisions for the long term good of the business...they're too concerned about the short-term "beauty contest".


This is one of the reasons for the LBO boom.


If we go back to Ben Graham, (i.e before Miller/Mogdiliani) the ideal amount of leverage was as much as you could get while still having a high investment grade. This would produce the highest ROE while keeping risk to an "acceptable level"


M/M showed that there was optimal amount of leverage, it could be calculated, and that amount was much higher than commonly thought.


A chunk of equity with a high ROE is worth more than the same chunk with a lower ROE. So the LBO artists are doing arbirtrage between the value of the equity of a fully leveraged company, and the public value of an underleveraged company.


Alot of companies should be financing their growth with debt, and looking hard at match funding themselves. I.e if you are an ethanol company building a plant with an expected 25 year life, take out a 25 year mortgage. Why do pharmacuitical companies/big energy companies have so much long term debt, because they invest in long term projects.


Back when companies where expected to pay out dividends, you had more debt, b/c there wasn't an endless amount of retained earnings to spend. Also, being expected to finance stuff with debt, causes companies to be focused on profitabilty.


The low prices on convertable debt, also suggest that alot of companies should be issuing convertable debt and buying back shares/ investing for growth. Given the recent explosion of the TRuPS market, I'm very surprised that companies aren't issuing more preferred stock.


BTW, alot of companies have huge amounts of off balance sheet leverage via operating leases. So something like Best Buy, isn't as underleveraged as it looks.



Jan 14, 2007 5:09 pm
AllREIT:
planrcoach:

The thing I don't get is, who actually borrows money for more than ten years, anymore? Everyone, every company, every government wants to refinance (for various reasons) in shorter timeframes.




Know anyone with a 30 year mortgage?



Have one myself. What are the odds that I will keep it for thirty years? What percentage of American mortagage debt is actually held long term, how does that influence the significance of the yield curve, is this changing due to the "creative" refinancing and repackaging of mortgage debt? What is the significance of the stop and start in issuing 30 year T bills? How much long term corporate debt is actually out there, are there significant trends in terms of historical amounts that bear on the yield curve. How does increasing national and consumer debt influence the yield curve, or desirability of owning long term debt. Do we just follow the textbook stuff about yields and economic cycle, or, in a globalizing economy, are there new trends that may affect portfolio allocation models?


Jan 14, 2007 5:14 pm

Taking a long view, it would seem to me to make sense for a reasonably profitable business to want to leverage up at today's long rates, essentially getting "permanent capital" at a cost of around 6-7%(or less depending upon their credit quality).  Of course, short term analysts will not like that, and short term it thus may hurt the stock, even though longer term it will give them more capital to deploy(if they have a place to put it profitably)

But that's generally the problem with today's environment....execs don't make decisions for the long term good of the business...they're too concerned about the short-term "beauty contest".


Very interesting comment.


This is more of what I am getting at - it is hard to get a perspective on the significance of this trend, along with, particularly, the trend toward more creative finance of traditional longer term consumer mortages (reverse mortgage, interest only, defaults, mobility).


Home mortages are only a part of long term debt, but housing, and home equity, seem to be what keeps the party going in recessions or good times now, for that matter.

Jan 14, 2007 7:17 pm
joedabrkr:



But that's generally the problem with today's environment....execs don't make decisions for the long term good of the business...they're too concerned about the short-term "beauty contest".


Amen, my brotha! Preach on...

Jan 14, 2007 8:01 pm

I can't imagine the yield curve not normalizing over the next 12-24 months, but who knows...

Jan 14, 2007 9:02 pm
planrcoach:
AllREIT:


Know anyone with a 30 year mortgage?

Have one myself. What are the odds that I will keep it for thirty years?


That really depends, go read up on RMBS prepayment if you want the answer.


What percentage of American mortagage debt is actually held long term, how does that influence the significance of the yield curve, is this changing due to the "creative" refinancing and repackaging of mortgage debt?


You need to get a whole bunch of Fabozzi's books, learn about the "term structure of interest rates".We are not going to do your MBA "Theory of Debt" class for you.


http://research.stlouisfed.org/publications/review/92/07/Str uctureJul_Aug1992.pdf


This is a good introduction to the issues.


As for the term structure, a 6 month rate should be equal to the average of the current 3 month rate plus the expected 3 month rate three months from now. Thus the entire curve is built up from the overnight rate (FFR) and imputed rates, between auctions.


Long yeild curves set mortgage rate's b/c most mortgages are packed into 30 year pools by FNM/FRE which are in turn priced off of 30 year pools made by the GNMA.


An inverted yeild curve implies that future overnight and short term rates are expected to be lower.


What is the significance of the stop and start in issuing 30 year T bills?


Get your terminology right. BTW 30 year T-bonds have been issued for quite a while since the start of the current administration.


1- year: T-Bill


1-10y: T-note


10y: T bond.


How much long term corporate debt is actually out there


Eleventy Kabillion, even more if you include CDO debt.  


 are there significant trends in terms of historical amounts that bear on the yield curve.


Yes, when the yeild curve is highly sloped, people don't issue long bonds, when it is inverted, people issue lots of long bonds. The US treasury explicitly does not time the market.


How does increasing national and consumer debt influence the yield curve, or desirability of owning long term debt.


Who's debt? All sorts of people put out long term debt. There is a world of difference between a 30year T-Bond and 30 year subordinated TRuPS.


Do we just follow the textbook stuff about yields and economic cycle, or, in a globalizing economy, are there new trends that may affect portfolio allocation models?


There are always new trends.

Jan 15, 2007 4:01 pm

Thanks for your thoughts. I guess since the price of most long term debt obligations is priced daily in the market, there will always be players who want to speculate on longer timeframe obligations. My intuition says that long term obligations are becoming less significant as a distinct asset allocation class, due to the economic factors mentioned. But I don't have any proof.