Real yields trades

Directional real yield trades—outright buying/selling. 

Forward real yield trades and forward BEI (inflation curve) trades. 

So we have formally introduced the notion of break-even inflation, a term at the heart of inflation-linked bond analysis and trading. In principle it is the rate of inflation that will equate the returns on an inflation-linked bond and a comparator nominal bond issue of the same term. In theory, calculating it by simply subtracting a real yield from a nominal yield is a crude form of a properly compounded calculation, particularly when bond market conventions are semi-annual and what you should want is an annual measure of inflation. 

As we have said already, trading in nominal space has its analogue in real space. So there are directional trades, real yield curve trades, and anomaly (or relative value ) trades between issues. There are also trades between the real and nominal markets, in inflation space — buying and selling break-even inflation, and expressing views on the term structure of break-even inflation. Exhibits 8.17 and 8.18 show histories of real yields and break-even inflation, respectively, for the three main European inflation-linked markets, while Exhibit 8.19 highlights the volatility in the UK s real yield and break-even inflation curves. 

Investors who perform break-even inflation trades may choose to weight them for expected differences in nominal and real yield volatility, or beta-weight them. Cross-market trades are also popular—selling break-even inflation in one market, and buying it in another, in order to express a view on future inflation differences between two economies. And market participants quickly become aware of seasonality in (unadjusted) CPI linking indices, trading into good carry months and out of bad carry months. ... 

Real yield and BEI difference trades between two markets. 

An important aspect of trading these bonds is using expectations of future monthly changes in linking indices, provided by economists, to calculate expected forward real yields and expected forward break-even inflation. Making assumptions about future price index levels allows these forward aggregates to be calculated in the same way that forward nominal bond prices and yields are worked out. 

Indexed bonds real yields in other markets are also a factor in investors decisions. The integration of markets around the world in the past twenty years has increased global capital mobility, enabling investors to shun markets where inflation is high. Over time, therefore, expected returns should be roughly equal around the world, at least in developed and liquid markets, and so should real yields. Accordingly, index-linked bonds should have roughly similar real yields, whatever market they are traded in. 

Part IV of this chapter will present the elementary theory of Second-Law cost accounting and its application to several practical cases, showing its usefulness for (i) costing "energy" commodities, (ii) plant operation decisions, and (iii) plant designs — new and retro-fit. These methods can be used to prescribe efficiencies and investments, traded-off against each other, but they will yield truly optimal results only to the extent that the real value (cost) of the "energy" supply is known. 

BA (real balance yield) and BA, (theoretical balance yield) play a central role in material flow analysis MFA (Trade Mark of BTC Dr. Dr. Steinbach GmbH, Mannheim, Germany). 

It is possible to infer market expectations about the level of real interest rates going forward by observing yields in government index-linked bonds, which trade in a number of countries including the US and UK. The market s view on the future level of interest rates may also be inferred from the shape and level of the current yield curve. Again from chapter 6, we saw that the slope of the yield curve also has an information content. There is more than one way to interpret any given slope however, and this debate is still open. 

Observing the trading patterns of a liquid market in inflation-indexed bonds enables analysts to draw conclusions about nominal versus real interest rates and to construct an inflation term structure. Such analysis is problematic, since conventional and indexed bonds typically differ considerably in liquidity. Nevertheless, as explained above, it is usually possible to infer market estimates of inflation expectations from the difference between the yields of the two types of bonds. 

Validation of EWCmodel-T)ne. regression analysis yielded high R values (0.8 or better) in six countries (Bangladesh, India, Pakistan, Indonesia, Malaysia, and China) and somewhat lower values (0.77 to 0.67) in another two countries (Sri Lanka and Thailand), thereby indicating that a real relationship exists between agricultural productivity and fertilizer use in these countries. In some countries lack of relationship or difference in CR can be explained by imprecise statistical data available, due to the nonregistered trade in fertilizers between some of the countries. 

We can apply the same logic with real-world bond prices and yields. Let us take a corporate bond first, the Ford 7M percent of February 2007, traded for settlement on January 6, 2006. This bond accrues interest on a 30/360 basis. 

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