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Bank of England begins emergency bond purchase programme to restore stability

bloomberg.com

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Re: Bank of England begins emergency bond purchase programme to restore stability

#11

Post by bko »

ctrlmeta wrote: post #8
yuan43 wrote: post #5

Earlier quoted context omitted.

It's a move designed to affect market psychology mainly. Multiple central banks have concluded that QE at best contributes marginally to the reduction of long term interest rates. People want something to be done, and BoE delivers. It also shifts the discussion from "what's causing the fall of the pound and the rise of long term rates" to "what will be the effect of this new round of QE?" To get a better picture, tak…

Can you explain what QE is and how long term rates are connected? Do you mean that the fall of pound is inevitably going to require UK banks to increase interest rates to make pound more attractive to investors? And what's the problem with increasing interest rates? Is it that rising interest rates makes new businesses difficult to borrow money? And difficulty in borrowing money leads to shrinking economy?

Interest rates are the price of money. Its how much you have to pay to borrow money. If there is a lot of money in the system, interest rates are low, and vice versa.

Interest rates are also inversely correlated with price. For instance, if I buy a bond that pays 5% for $100 and tomorrow someone can lend money at 6%, no one is going to pay $100 for a bond that's paying only 5%. If they can lend money now only at 4%, they'd pay over $100 for the bond paying 5%.

BoE is going to be buying a lot of bonds, which means the price is going up (increase in demand) and others will pile in. And since price and interest rate are inversely correlated, that means yields (interest rates) are going down.

Similarly if interest rates go up, the bonds that banks and pension funds hold will go down in price (inversely correlated). But the downside is there's more money in the system, cheaper credit, more inflation and decrease the valuation of the currency relative to other currencies.

Re: Bank of England begins emergency bond purchase programme to restore stability

#12

Post by boppo1 »

ctrlmeta wrote: post #3

I asked this in a different post but did not get any answer, so asking it here hoping someone can help me understand this. Can someone more financially literate than me explain how BoE buying government bonds is going to restore financial stability? Will it slow down the falling pound? Will it reduce inflation? What mechanisms are at work here?

Someone correct me if I'm wrong[3]:

1. Buying bonds pushes the price of bonds up (pretty basic, right?)

2. Bonds have a constant interest payment, so if you buy a higher priced bond, the size of that return as a % of what you paid (yield) is smaller.

3. When you evaluate risky[0] securities (company stocks and bonds) or other risky financial investments, you compare them with something risk-free[1] like government bonds.

4. More specifically, to determine how much something is worth now, you calculate Net Present Value (NPV) using the Discounted Cash Flow (DCF) method. This is the method that all serious financial companies employ[2] on some level to determine the prices of things.

5. NPV is the sum of each (future cash flow / (1 + discount rate)^t) where t=compounding periods (typically years) and the discount rate is the benchmark rate that you're comparing to.

6. Hence, if you are using government bond yields as the discount rate in your calculation, if the yield goes down, your NPV goes up. So by lowering government bond yields, you help support the price of financial assets.

7. If you are not familiar with finance, you may be inclined to ask "hold on that seems like it supports stock prices not the actual economy" "what about the value of money?" "what about the quality of activity being supported?" "once you start, how do you stop?". Interfering with the 'natural' rate of interest on benchmark securities was and remains a hotly contested topic, however it has been accepted as a status quo method in western economies that feature a central bank.

[0] not risky as in Gamestop, but risky as in 'any investment that could possibly go badly'

[1] We generally treat US treasuries, and sovereign debt for stable countries like the UK and Germany as 'risk-free'. If these borrowers ever default, we probably have bigger problems to deal with than the valuation of Coca-Cola.

[2] Lots of valuations are not calculated using DCF, companies often just use comparables and 'multiples' (literally just value something by saying it's "10x earnings/ebitda (current period cash flow)". However, this is mostly just companies that need to make lots of valuation calls very quickly and off-the-cuff. Generally speaking DCF is the 'fundamental theory' of valuation, and then other more or less complex models are built off of its ideas. I.E. adding coefficients of probabilities, what-if scenarios, etc to future cash flows.

[3] which is possible given I'm laughably unemployed

Re: Bank of England begins emergency bond purchase programme to restore stability

#14

Post by dragontamer »

ctrlmeta wrote: post #3

I asked this in a different post but did not get any answer, so asking it here hoping someone can help me understand this. Can someone more financially literate than me explain how BoE buying government bonds is going to restore financial stability? Will it slow down the falling pound? Will it reduce inflation? What mechanisms are at work here?

> Will it reduce inflation?

No. Apparently the BoE is worried about other things right now, rather than inflation.

Which sounds pretty bad, because it seemed like inflation should be the #1 concern right now. But BoE has other economic data and are clearly worried about something else...

> Can someone more financially literate than me explain how BoE buying government bonds is going to restore financial stability?

Nominally, you'd do this if you were worried about deflation. I don't know what kind of economic data suggests deflation right now though...

Re: Bank of England begins emergency bond purchase programme to restore stability

#15

Post by presioneaqui »

ctrlmeta wrote: post #3

I asked this in a different post but did not get any answer, so asking it here hoping someone can help me understand this. Can someone more financially literate than me explain how BoE buying government bonds is going to restore financial stability? Will it slow down the falling pound? Will it reduce inflation? What mechanisms are at work here?

1) Pension funds (and other institutional investors) own government bonds. 2) They have also purchased risk/hedging products and posted these bonds as collateral. 3) As interest rates rise, the value of these bonds fall. 4) As the value of these bonds fall, these institutions are asked to post more collateral. 5) To come up with more collateral, they sell more of their bonds, dropping the price even more. 6) They are asked to post more collateral....death spiral.

The BoE buying these bonds applies the brakes on bond prices and "restores financial stability".

Re: Bank of England begins emergency bond purchase programme to restore stability

#16

Post by mamonster »

presioneaqui wrote: post #15
ctrlmeta wrote: post #3

I asked this in a different post but did not get any answer, so asking it here hoping someone can help me understand this. Can someone more financially literate than me explain how BoE buying government bonds is going to restore financial stability? Will it slow down the falling pound? Will it reduce inflation? What mechanisms are at work here?

1) Pension funds (and other institutional investors) own government bonds. 2) They have also purchased risk/hedging products and posted these bonds as collateral. 3) As interest rates rise, the value of these bonds fall. 4) As the value of these bonds fall, these institutions are asked to post more collateral. 5) To come up with more collateral, they sell more of their bonds, dropping the price even more. 6) They are…

This is the only correct answer I'm seeing so far here. Article clearly states BoE is avoiding rolling margin calls that could get triggered this week. Right now it is all about bailing out pension funds.

One other note: They could also be holding these bonds themselves on leverage. They could be asked to post cash as collateral for these bonds(which are now essentially risky assets).

Re: Bank of England begins emergency bond purchase programme to restore stability

#17

Post by ctrlmeta »

presioneaqui wrote: post #15
ctrlmeta wrote: post #3

I asked this in a different post but did not get any answer, so asking it here hoping someone can help me understand this. Can someone more financially literate than me explain how BoE buying government bonds is going to restore financial stability? Will it slow down the falling pound? Will it reduce inflation? What mechanisms are at work here?

1) Pension funds (and other institutional investors) own government bonds. 2) They have also purchased risk/hedging products and posted these bonds as collateral. 3) As interest rates rise, the value of these bonds fall. 4) As the value of these bonds fall, these institutions are asked to post more collateral. 5) To come up with more collateral, they sell more of their bonds, dropping the price even more. 6) They are…

> 4) As the value of these bonds fall, these institutions are asked to post more collateral.

Why do the pension funds (and other institutional investors) need to post collateral? Where do the pension funds post their collateral to?

I guess I will understand why collateral is required if you can explain me what would go wrong if the pension funds were not made to post collateral.

Re: Bank of England begins emergency bond purchase programme to restore stability

#18

Post by mamonster »

ctrlmeta wrote: post #17
presioneaqui wrote: post #15

Earlier quoted context omitted.

1) Pension funds (and other institutional investors) own government bonds. 2) They have also purchased risk/hedging products and posted these bonds as collateral. 3) As interest rates rise, the value of these bonds fall. 4) As the value of these bonds fall, these institutions are asked to post more collateral. 5) To come up with more collateral, they sell more of their bonds, dropping the price even more. 6) They are…

> 4) As the value of these bonds fall, these institutions are asked to post more collateral. Why do the pension funds (and other institutional investors) need to post collateral? Where do the pension funds post their collateral to? I guess I will understand why collateral is required if you can explain me what would go wrong if the pension funds were not made to post collateral.

Big banks. A bank lending any sort of investment vehicle money to essentially purchase assets on leverage is called a prime broker.

Re: Bank of England begins emergency bond purchase programme to restore stability

#19

Post by mistrial9 »

bko wrote: post #7

> The BOE decided to intervene to get ahead of a potential crisis that could have hit within hours. It was concerned collateral requirements on liability-driven investment strategies, such as those at pension funds, would have turned many into forced sellers of long dated gilts, according to a person familiar with the situation. I often hear people complain about the end of defined benefit pensions, but this is what…

According to urban legends, in the events leading to the 2007-8 western financial crisis, when loans from lenders like Washington Mutual were being handed out by the dozens to clearly unqualified borrowers, there was a short acronym that was repeated on notes and word of mouth between dazed and skeptical financial employees IWBT-YWBT

I won't be there - You won't be there

literally meaning, the due date for these loans and the trouble they are making, will occur after you and I, fellow white collar worker, will be long gone.

In the years following those famous financial events, a large scale opioid medication abuse pattern emerged across the USA. What could be clearer in hindsight?

some people refused to participate, and some people profited, and far, far more people were financially damaged in a way that lingers today in the USA and elsewhere.

Re: Bank of England begins emergency bond purchase programme to restore stability

#20

Post by [deleted] »

mamonster wrote: post #18
ctrlmeta wrote: post #17

Earlier quoted context omitted.

> 4) As the value of these bonds fall, these institutions are asked to post more collateral. Why do the pension funds (and other institutional investors) need to post collateral? Where do the pension funds post their collateral to? I guess I will understand why collateral is required if you can explain me what would go wrong if the pension funds were not made to post collateral.

Big banks. A bank lending any sort of investment vehicle money to essentially purchase assets on leverage is called a prime broker.

[deleted]
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