The attention of savers is now focused on government bonds. Here we will deal in particular with Bot and the Ctz. questi two securities are "zero coupon": it means that they do not pay coupons during their life. However, most financial intermediaries do not provide sufficient information to validly compare the various investment choices. To this end, with this post we try to provide our readers with a handbook to understand the convenience of investing in these instruments. The analysis by the saver, in fact, must be carried out in terms of: yield to maturity, liquidity risk and interest rate risk. Let's look at them specifically.
- The yield to maturity it is the tool used to compare alternative investments with each other: e.g. Bots/Ctzs versus BTPs. It is calculated as the difference between the redemption price (100) and the purchase price, parameterized on the number of days remaining to the expiry and always transformed on an annual basis. Many intermediaries do not offer the yield to maturity, however it is always advisable to calculate it before buying a "zero coupon" security. Thanks to the calculation of the yield to maturity, it is possible to compare the yields of "zero coupon" securities and that of securities with coupons of the same duration (e.g. BTPs and CCTs).
- The liquidity risk – An immediate indicator of such risk is lo bid/ask spread, i.e. the difference between the quotation for those who buy and those who sell at a given moment. And the immediate remuneration for those who list the securities. The greater the difference between the purchase price and the sale price (see image), the less the exchanges that take place in the market, while the greater the difficulties and costs of disinvesting the security before expiry.
- Rate and duration risk - Interest rate risk is the risk that the investor undergoes when market rates vary. Volatility, ie the erratic nature of market rates, mainly impacts: on the price of securities on the possibility of reinvesting any coupons. Duration – or average financial duration – is one of the most used tools to measure interest rate risk. The duration measures the security's sensitivity to changes in interest rates: a variable rate bond has a "duration" very close to zero, because the coupon rate periodically adjusts to changes in the market and the price has the advantage of being very stable; a fixed rate bond has a higher duration than a floating rate bond; a "zero coupon" security has a "duration" equal to its duration. Therefore, compared to investments in securities with coupons, by investing in "zero coupon" securities one runs greater interest rate risks (and therefore greater risks of price fluctuations). Therefore, in the event that there is a need to sell the securities before expiry, it is good to take this into account. On the other hand, those who invest in a "cash-holder" perspective, i.e. intend to hold the securities until their maturity, are relatively indifferent to the duration risk.
A simulation of net returns – In the end, what the saver takes home is the after-tax return. In the exemplary simulation (see the second image) the gross returns and the returns after taxes are shown. Government bonds have a different tax treatment than bank bonds and bank deposits, the latter instruments subject to higher withholding taxes (20%). Therefore, in order to correctly evaluate the investment alternatives on the market, the yield after taxes must necessarily be considered. In addition, the brokerage cost (commissions) established by each intermediary which, if they are established in a fixed amount (eg always 0,15% on the purchase of government bonds), have a greater impact on yields of shorter duration.
In conclusion, for a correct evaluation of the investment choices in fixed-income instruments, it is necessary to compare the returns with the same maturity, simultaneously verifying the liquidity risk and the interest-rate risk, finally comparing the returns also net of taxes and commissions if there were differences in tax treatment.
by Laura Oliva
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