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Speaker 1: Welcome to Ask Fear and Greed, where we answer questions

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Speaker 1: about business, investing, economics, politics and more. I'm Michael Thompson. Hello,

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Speaker 1: Sean Aylmer.

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Speaker 2: And Michael, what's the grid on your face for?

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Speaker 1: Because this question today is just It would almost be

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Speaker 1: one that you had written yourself this question if it

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Speaker 1: hadn't come from Craig on LinkedIn. And so Craig wrote us,

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Speaker 1: say a note and he says, Hi, one for the

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Speaker 1: Ask Fear and Greed. Can you please explain a dummies

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Speaker 1: guide to government bonds? Ah, he says, I suspect many

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Speaker 1: don't know what they are and how they work. And

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Speaker 1: I think I'm reasonably intelligent, and I find them a

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Speaker 1: bit hard to understand.

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Speaker 2: I think they're really hard to understand. So I mean,

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Speaker 2: I'll try and give a dummies guide, but what it

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Speaker 2: is once you get the basics, there are so many

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Speaker 2: kind of add ons in the government bond. In the

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Speaker 2: bond market will stick to government bonds, so most manilla

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Speaker 2: a bond just an iou right? So governments issue bonds

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Speaker 2: to cover the spending they can't fund through taxes, and

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Speaker 2: revenue tax comes in, you've got a big deficit, You've

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Speaker 2: got to pay for it somehow. You issue a bond, right,

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Speaker 2: I owe you this money. So they go to a

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Speaker 2: super fund. So you know, give U one hundred million

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Speaker 2: bucks and we'll pay for what we're spending our money

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Speaker 2: on and we'll pay you back in the future. So

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Speaker 2: that's all kind of it's just alone, as fairly is.

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Speaker 2: The safest investment in financial markets is a US government bond.

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Speaker 2: They're safer than banks, right because a bank can fail,

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Speaker 2: but a government can literally print money. Same deal in Australia.

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Speaker 2: Safest asset in Australia an Australian bond because they are

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Speaker 2: considered the risk free rate of return, although theoretically there's

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Speaker 2: always risk.

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Speaker 1: So the closest thing to a closer.

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Speaker 2: Thing every anything else is priced off government bonds. This

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Speaker 2: is why we care so much about them. So your

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Speaker 2: mortgage is priced off whatever the government bond rate is. Equities,

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Speaker 2: business lands, credit cards, the whole shebang. It comes down

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Speaker 2: to the foundation rate of return.

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Speaker 1: In order to truly answer Craig's question, can you give

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Speaker 1: us paint a picture for us, give us an example.

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Speaker 2: It's probably so. Let's end the government sells a bond

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Speaker 2: to an investor for a million bucks.

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Speaker 1: Gotcha right, yep, A lot of the way that you're

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Speaker 1: looking at me, just go has he understood that Part'm like, yes,

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Speaker 1: I got that partch on.

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Speaker 2: Okay, they pay interest on that. They call that a

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Speaker 2: coupon rate. Okay, let's say it's five percent. That means

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Speaker 2: Michael Thompson's buying the bond for a million bucks and

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Speaker 2: getting fifty thousand dollars coupon payment every year.

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Speaker 1: Yep with me so far, Yep, sounds good to me.

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Speaker 2: Excellent. Then you think to yourself, hmm, I'm getting on this,

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Speaker 2: but I actually wouldn't mind investing somewhere else. I wouldn't

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Speaker 2: mind getting the million bucks back and investing in inequities

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Speaker 2: or spending at some you know, buying a new house

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Speaker 2: or doing whatever. Okay, So you can sell that bond

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Speaker 2: in what they call the secondary market. So there are

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Speaker 2: other people out there who might like the safety of

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Speaker 2: a bond. Say, okay, we'll buy that from Michael good great, okay,

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Speaker 2: million dollar bond, five percent coupon rate. You go to

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Speaker 2: the market to sell ex you don't want it anymore,

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Speaker 2: but things have changed. No one's going to give you

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Speaker 2: a million dollars for that bond anymore because returns only

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Speaker 2: five percent, and stuff's happened. So I say, okay, Michael,

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Speaker 2: well give you nine hundred thousand dollars for that bond,

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Speaker 2: oh dear. But you think, well, I prefer to have

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Speaker 2: nine hundred thousand dollars and invest it somewhere else, or

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Speaker 2: buy a house, to do whatever you're doing. So you say, okay,

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Speaker 2: you take the nine hundred thousand. The person that buys it,

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Speaker 2: Sean takes a nine hundred thousand. I'm still getting that

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Speaker 2: five percent coupon rate. So my return, which they called

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Speaker 2: the yield, is fifty thousand on nine hundred thousand. Yours

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Speaker 2: was fifty one million.

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Speaker 1: Oh so the coupon rate is off the original.

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Speaker 2: The coupon rate never changes. That's why it's called fixed income. Okay,

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Speaker 2: all right, all right, the concepts you've got to think

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Speaker 2: of the price, yep, the coupon rate, the yield. The

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Speaker 2: yield is what I get back because I've paid less

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Speaker 2: for it. The price is falling, I get back, so

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Speaker 2: kind of it's always counterintuitive when bond prices four yields rise.

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Speaker 2: That's actually the main thing you've got to remember.

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Speaker 1: I get that, don't laugh. I genuinely get that.

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Speaker 2: That is a So when you hear about to sell

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Speaker 2: off in bonds, what you're saying people are paying less

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Speaker 2: for them. We don't want these bonds, And that's what

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Speaker 2: happened in the US last week. We're worried about US bonds.

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Speaker 2: We don't want them as much. So the price is

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Speaker 2: four their returns go.

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Speaker 1: Up, and that's in the secondary yield.

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Speaker 2: That's all in the secondary market. Understood. Once you know

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Speaker 2: that coupon rate of five percent, you kind of forget

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Speaker 2: about that. You just worry about the price in the

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Speaker 2: YIELDEP and so the yield, and that makes sense because

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Speaker 2: if people think, oh, sorry, look you're looking at me.

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Speaker 1: No, no, no, no. The look on my face is like

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Speaker 1: it is an epiphany right now because you've just explained

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Speaker 1: that in such a clear way.

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Speaker 2: The next stair, which I'll probably just confuse matter so

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Speaker 2: you understand what's going on so far.

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Speaker 1: One hundred percent. I was hoping that was where I

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Speaker 1: was going to finish, because then I would be with YEP.

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Speaker 2: Last week, the US government tried to raise money. They

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Speaker 2: wanted to issues and bonds. Right all of a sudden, though,

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Speaker 2: people are getting a yield of you know, let's say

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Speaker 2: five point six percent, not five percent. They paid less.

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Speaker 2: The new bonds are going to the market right at

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Speaker 2: a million dollars. Still, the coupon rate suddenly has to

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Speaker 2: match what's in the market. Okay, So the upon rate

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Speaker 2: goes to five point six percent, not five percent.

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Speaker 1: Okay, No, I do get that, get that?

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Speaker 2: Yes, And what happened last week is the US government said, Okay,

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Speaker 2: we're going to issue new bonds. Oh, okay, we have

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Speaker 2: to play a higher coupon rate than we did three

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Speaker 2: months ago. Yep, because we need to compete with what's

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Speaker 2: going on in that secondary market. And that's why bond

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Speaker 2: markets rule, because the US government's like, oh, hold on,

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Speaker 2: that's just increased the cost of debt. Donald Trump's trying

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Speaker 2: to cut costs. No, no, He's actually just bought himself

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Speaker 2: a lot more debt by pushing up that coupon rate.

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Speaker 2: And so when we say bond markets rule, bond markets

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Speaker 2: do rule because they said interest rates on everything else,

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Speaker 2: they're risk free. But also they determine what the government

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Speaker 2: has to pay to raise money.

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Speaker 1: I think, not only have you done Craig a service today,

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Speaker 1: you have done everyone who's ever been unsure about how

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Speaker 1: bonds work a service.

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Speaker 2: Now, this is very vanilla. There are all sorts of

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Speaker 2: iterations and you get corporate bonds. And as long as

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Speaker 2: you understand the basics, yeah, we can do basics, we

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Speaker 2: can a lot. I'm about to suggest this, We're going

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Speaker 2: to do a whole series on bonds. Let's not. Let's leave,

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Speaker 2: by the way.

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Speaker 1: Unless we rename them, as we've discussed before, give them

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Speaker 1: a sexy name like James Bond, James Bonds.

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Speaker 2: Or Alan Bond's Alan Bond's Yeah, not so good ones

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Speaker 2: the Alans and really good ones to James Bonds.

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Speaker 1: And if you guys really well, it's bonds a time

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Speaker 1: to rap u Yeah, I think that'll do us. Craig, Look,

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Speaker 1: you know what I don't even need to say. I

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Speaker 1: hope we answer the question because I know that Sean

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Speaker 1: has done a good job of answering that one. I

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Speaker 1: hope you enjoy it. And if you have your own

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Speaker 1: question that you would like us to answer them, please

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Speaker 1: send it on through. Do it, Craig. Did jump onto

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Speaker 1: Instagram or LinkedIn or Facebook or go to Fear and

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Speaker 1: Greed dot com to are you and send us a

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Speaker 1: question while you're signing up for the Fear and Greed

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Speaker 1: Daily newsletter on the same website. Thank you Sean, Thank

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Speaker 1: you Michael oh Michael Thompson, and that Ask, Fear and

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Speaker 1: Greet