Bond Market Analysis Report: US, UK, and Australia (ECON1239)

This finance report provides a comprehensive analysis of the bond markets in the United States, the United Kingdom, and Australia. It delves into key concepts such as yield to maturity (YTM), discount rates, and real interest rates, utilizing real-world bond data to replicate realistic predictions for future inflation and interest rates. The report includes detailed tables comparing bond prices and YTM across the three countries, calculates real interest rates based on inflation forecasts, and compares investment opportunities. The analysis further explores the implications of these findings on the stock market, comments on the US Treasury Inflation-Protected Securities (TIPS), and examines the structure of interest rates. The report concludes with an analysis of the relationships between bond yields and stock market performance, offering insights for potential investors.

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Bond market analysis report
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Introduction
This report is an analysis of the several aspects regarding the bond financial market. In
this report, major emphasis of the report is allocated to towards assessing and analyzing concerns
such as Yield to maturity level of different countries. Therefore, the selected countries to be used
for analysis include the United of America, Australia, and the United Kingdom. For the purpose
of better a better understanding, relevant terms will be briefly explained and they include:
Discount rate:
Definitions regarding the discount rate can be sub divided into two major categories to
include calculations relating to present values and secondly the regarding interest rates charged
by the central bank of an economy (Lee, 2016) The discount rate of the central bank is that
particular rate that the federal bank charges on loans given to other commercial or banks within
an economy.
Bond market
A bond market can be referred to a financial platform through which an investor can
carry out trading in the government issued securities and assets. These government securities are
normally considered to be risk free assets and thus they attract low rate of return (Sims, 2017).
Yield to Maturity:
The yield to maturity refers to the total expected return that an investor forecasts to
generate from the purchase of a government bond or security at maturity. It is expressed in terms
of terms of an annual rate and it is mainly calculated for the long term loans and government
securities.

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PART 1A:
Table 1: bond market YTM and prices for the three chosen countries.
US
BOND
MARKE
T
us
bond
prices
AUSTRLIA
L BOND
MARKET
Australia
n bond
price
UK-
BOND
MARKE
T
uk
bond
price
(GBP)
YEAR YTM ($) YEAR (AUD)
YTM
(%) YEAR
YTM
(%) (GBP)
1 0.13 98.88 1 107 0.81 1 0.48 105.59
2 0.39 99.74 2 108.08 0.75 2 0.37 106.49
5 1.72 99.7 5 109.1 0.72 5 0.3 103.16
10 3 99.5 10 117.41 0.96 10 0.49 103.71
20 3.68 101.3 20 122.52 1.38 20 0.88 102.02
30 3.92 102.67 30 123.15 1.6 30 0.96 120.02
Bloomberg, 2019
PART 1B:
Table 2: the Discount Rates Using the Approximate Method
US
discou
nt rate
AUSTRALI
AN
DISCOUNT
RATE
year DR
1 0.13 0.81
1-2 years 0.133 0.82
3-5 years 0.45 0.154

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6-10 years 0.1 0.22
11-20 years 0.66 0.87
21-30 years 0.35 1.35
PART 2: Real Rates of Interest
A real interest rate is an inflation adjusted rate eliminating the possible effects of
inflation. The real interest rate therefore acts as a reflection for the actual cost of capital, funds,
and investments and so on. For instance, this type of interest rate is the actual costs to the
borrower and it is the actual yield to the lender or investor (Plecher, 2019). Inflation on the other
hand can be defined as a general increase in the prices of commodities and services over a given
period. High inflationary rates in a country signify low economic growth together with low
purchasing power (U.S department of the treasury. 2019). On the other and low or average
tendencies of inflation show a relatively sound economic performance and development.
Therefore the following data is a representation of the prevailing economic climate in the chosen
countries. The following formula will be used to forecast the real interest rates. Nominal interest
rate however refers to the sum of the expected inflationary rates and the forecasted real interest
rate within a given period.
Real interest rate = 1+nominal rate
1+ inflationrate – 1
The table3: inflation forecast for the chosen countries

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US
discoun
t rate
US inflation
rate
Australia
inflation
predictions
UK inflation rate
forecast
DR
0.13 2.3 1.9 1.7
0.133 2.1 2.27 2.04
0.45 2.2 2.52 2.05
0.1 2.1 2.5 2.04
0.66 2.3 2.55 2.02
0.35 2 2.55 2.02
bank of England, 2019
Table 4: real interest rate between US and Australia
year real interest values
united states Australia
1 year -0.66 -0.38
1-2 year -0.63 -0.44
3-5 year -0.55 -0.28
6-10 year -0.65 -0.65
11-20 years -0.45 -0.47
21-30 years -0.33 -0.34
Part 3: comparing the predicted rates
According to (Pettinger, 2017), a negative real interest rate is an implication that
prevailing inflation in an economy is higher than the interest rates. Therefore, having a negative
real interest in an economy implies that businesses can freely borrow money from the central
banks. According to the above statements therefore, the United States offers a better investment
opportunity as compared to the Australian economy. For instance the 1 - year US real interest
rate of -0.66 would is am implication that if an investor would realize returns of about 66% as
compared to the possible 38% return of Australia.

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Justification for the assumption to use constant inflation rates is derived from the point
argument that TIPS are continuously adjusted for inflationary tendencies. Similarly, because the
TIPS are categorized as inflation protected securities, fluctuations in the inflationary level would
not have very significant impacts on the market (Kenny, 2019). Additionally, depending on the
recently published finical data, existing differences between bond yields has been reducing
aggressively up to about 1.60%. This can therefore be used a firm basis for predicting or
assuming that inflation in the bond market will be constant.
Alternatively for individuals intending to save, a negative real interest rate is rather a
demotivating factor. Due to the fact that negative real interest rates signify that the inflation in an
economy is much higher than the bank rates, there is little or no potential for value and return.
Therefore, according to such a perspective in which people desire to save their funds, the
American, United Kingdom and Australian economies don’t appear to be providing good
incentives for people who are willing to save their incomes. Since all these economies have
almost similar inflationary trends, the results and implications to real interest rates would be
almost the same. When the inflation rates are high, consequently real value of funds and the
national currency declines in real terms on the financial market.
These comparisons further create conducive environment for investment for both the
domestic and international investors. Because real interest rates imply that businesses can borrow
money and funds, then the cost of carrying out economic activity is made much cheaper.
Therefore, investment in the economies such as the United States, UK and Australia proves to be
rather financially a viable venture. Such negative real interest rates of the two countries are a
sign that economies are undergoing recession periods.

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Part 4: Comments on the US TIPS (Treasury Inflation Protected Securities)
The treasury inflationary securities (TIPS) are among the various types of US treasury
bonds and securities that are designed to aid investors while trying to protect themselves from
the threats of inflation. Investors who allocate who decide to allocate funds in buying such bonds
are entirely fully and legally entitled to fixed interest rates and they are under the protection of
the US federal government. In an economy where the inflationary tendencies continue rise, the
investors are significantly protected against loss of value for their funds. This is due to the fact
the US TIPS are known to gain and retain value in cases where the inflation continues to sore.
On the contrary however, declining rates of inflation would adversely result into loss of value for
the TIPS investors. According to the forecasted inflationary tendencies therefore, the current and
future inflationary trends imply that US TIPS holders are likely to generate value for their funds
and investments. This is fully supported by the 2.3% levels of inflation in the country. Since high
levels of inflation imply the losses in monetary value within an economy, these TIPS are
performing well. However, from the available projections and forecasts on inflation trends, these
TIPS bonds are most likely to lose value in the near future. For instance in the next 21-30 years,
the united states is expected to experience inflationary declines up to around 2.0 %. This would
imply that the bonds will not be a valuable venture or asset.
Part 5: How the YTMS Have Been Changed
Over the past six months of financial trading in the US bond market; there is a clear
reflection that the yields to maturity returns have been undergoing slight improvements. For
instance, the USS bond market was identified to be having a 2.28% level of YTMS during the
month of April. However, this has been slightly increased further with about 0.03% to an

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estimated 2.31 percentage return on bonds in the market over the past three months. Some of the
possible explanations for such a trend could be the slight increases in inflationary levels within
the United States economy.
Basing on the available information on the bond market, a 5-yearYTMSshows that the
market return was significantly collapsing. This is evident from the 1.85% return at maturity and
a further 1.84% in the 2-year YTMS. Possibly, these 5 and 2-year returns are simply a reflection
that the US general economy was experiencing tendencies of deflation. As discussed in the
previous parts of the paper, an economy that is undergoing deflationary tendencies results into
low returns in the bond markets and it is such a trend that caused the decline (Phillips, and
Grocer, 2019). However, over the past 12 months, inflation started setting in and from such a
point, investors started feeling insecure hence they started realizing the need to protect and guard
against the possible outcomes.
Part 6: structure of interest rates
The structure of interest rates is an explanation that is used to create, assess and analyze
the existing relationship between interest rates and bond yields within an economy in a given
period. Alternatively this structure of interest rates can also be referred to as a yield curve (Reid,
2019). Closely related to the law of demand and supply, an increase an increase in the level of
interest rates implies a reduction in bond returns. When the returns on government bonds
declines, the demand for such bonds would as well drop and the bond prices charged are as well
reduced (Bank of England, 2019). This is because increasing interest rates attract potential
investors to more profitable economic activities. On the other hand however, when the interest

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rates are lowered, investors become insecure in the market and they resort to taking protective
measures which results into higher prices on the bond market.
Therefore, by relating such an interest structure to the case in point, negative bond yields
would imply that the American economy is likely to result into significant drops in the interest
rates on the market (Patton, 2013). The federal government would undertake a contractionary
economic policy so as to reduce the amount of money in circulation so as to regulate economic
activity. By lowering interest rates even the profitability would be reduced and people would
resort to protectionist habits. In the long run the bond value would be revived thereby correcting
the negative returns in the bond market.
Part 7: comment on excerpt
In line with the statement from the economist, it is highly evident that investors are
majorly interested in high returns. The fact that these bonds such as the US TIPS are associated
with low returns, all rational investors will require higher returns with longer periods of
investment in government bonds (Pettinger, 2017). Short term bond investments appear to be
more attractive than the long term alternatives. This is one of the reasons as to why investors
would opt to allocate funds in securities of 1 to 3 years because such securities give them the
liberty to reallocate fund in a shorter period.
Part 8: implications of the findings on the stock market

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The existing relationship between yields and the stock market is closely dependent. For
instance, declines in the bond yields ultimately render investment in bonds unprofitable.
Therefore, due to unprofitability within the bond market, investors tend to opt for riskier
investments in the stock market. They therefore withdraw all their funds and decide to invest in
more profitable equity stocks. On the other had however, if the equity markets become
subsequently subjected to treats such as inflation, investors seek security and protection by
purchasing these risk free bonds and such a cycle continues.
From the above discussions concerning interest rates, real interest rate, inflation and
yields returns to maturity, federal governments often aim at specific objectives and goals.
Making decisions such as lowering nominal interest to promote activities such as borrowing
ultimately results thereby increasing money in circulation. Investment would at the same time be
promoted business entities would gain access to funds at almost no cost. In the long run
however, undertaking such an economic policy would negatively cripple the economy. This
would most prominently occur in situation where inflation becomes higher than the real interest
rates. Having negative real interest rate values would imply that the economy cannot fully
support real exchange in the market.

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Bank of England. 2019. Prospects for Inflation: Section Five of The Inflation Report- February
2019. Retrieved from https://www.bankofengland.co.uk/inflation-report/2019/february-2019/
prospects-for-inflation
Bloomberg, 2019. Rates and Bonds. Retrieved from
https://www.bloomberg.com/markets/rates-bonds
Kenny, T. 2019. Why Bond Prices And Yields Move In Opposite Directions. Retrieved from
https://www.thebalance.com/why-do-bond-prices-and-yields-move-in-opposite-directions-
417082
Lee, R. 2016. How To Forecast Future Inflation Rates. Retrieved from
https://blog.wealthfront.com/forecast-inflation/
Patton, M. 2013. Why Rising Interest Rates Are Bad For Bonds And What You Can Do About It.
Retrieved from https://www.forbes.com/sites/mikepatton/2013/08/30/why-rising-interest-rates-
are-bad-for-bonds-and-what-you-can-do-about-it/#531badc56308
Pettinger, T. 2017. Negative Real Interest Rates. Retrieved from
https://www.economicshelp.org/blog/2374/economics/negative-real-interest-rates/
Phillips, M., Grocer, S. 2019. The Bond Market Is Trying To Tell Us Something (Worry): The
New York Times. Retrieved from https://www.nytimes.com/2019/05/30/business/bond-yield-
curve-recession.html
Plecher, H 2019. Ausrtalia:Inflation Rate From 1984 To 2024* (Comapared To The Previous
Year). Retrieved from https://www.statista.com/statistics/271845/inflation-rate-in-australia/
References

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Reid, D. 2019. Negative Bonds Yields Are Not Reflecting Economic Reality, Fitch Warns.
Retrieved from https://www.cnbc.com/2019/08/13/negative-government-yields-dont-support-
credit-rating-fitch-warns.html
Sims, E. 2017. Bonds, Bonds Prices, Interest Rates, and the Risk and Term Structures of Interest
Rates: ECON40364: Monetary Theory And Policy. Retrieved from
https://www3.nd.edu/~esims1/slides_bonds.pdf
U.S Department of the Treasury. 2019. Daily Treasury Yield Curve Rates. Retrieved from
https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?
data=yieldYear&year=2014