Financial Markets

“Century” Bonds a Sign of the Times

By June 5, 2015 No Comments

In a sign of today’s yield-starved world, one of the world’s most indebted companies was able to raise $2.5bn by issuing bonds that mature in the year 2115 at a yield of 8.45%. In fact, the issue was 5x over-subscribed.

Plagued by corruption, Brazilian oil producer Petrobras has been cut off from global debt markets. At the end April, it convinced auditors to sign off its delayed financial statements by booking corruption-related losses, averting possible bankruptcy and allowing the company to issue fresh bonds.

Petrobras has stormed back to international capital markets, selling $2.5bn in “century” bonds. This is the first US dollar denominated bond issue by the Rio de Janeiro-based company since March last year.

It’s not an investment – it’s a wager on the path of interest rates (inflation), oil prices, government intervention (fuel subsidies), endemic corruption and litigation risks, to name a few. For the next 100 years.

However, while investing in a bond that will not be redeemed until your grandchildren retire seems to imply reckless assumptions about Petrobras’ survival chances, the mathematics of bonds show that such existential questions aren’t as important as they might appear when proper account is taken of payments to be made so far into the future.

The value of a bond is simply the sum of all future interest payments and the final return of your principal, with each amount tallied in today’s dollars.

It turns out that if you decide to lend Petrobras $1,000 this week in return for annual interest payments of 8.45% for the next century, whether you get your $1,000 back at the end or not is largely irrelevant. Using a “discount rate” of 8.45%, the return of your $1,000 of principal in 100 years time has a present value of less than 30 cents.

Nonetheless, these bonds are an interesting curiosity, not something for an individual investor’s portfolio.

Bonds play an important role as the stabilisers of your portfolio. They are there to dampen fluctuations in value, and provide dry powder to buy shares and other riskier assets on the cheap during periods of market disruption. For individual investors, these bonds won’t satisfy either criteria.

As with any investment, attempting to evaluate the risk/return characteristic of a single asset isolated from the portfolio it will be harmonising in concert with is wasted effort. You can’t taste the butter to determine its effect on the finished cake.