Currency / bond yield

CFA Level III
#1

Hi Brave Ones,

Would truly appreciate your comments on this if possible.

Reading 18 - CFAI Volume 3 - Page 78

Even if countries are not trying to link their currencies, bond yields can diverge substantially between countries. For example, if one country’s exchange rate is severely undervalued and is expected to rise substantially against another country’s, then bond yields in the first country will be lower than they would oth- erwise be in relation to the other country

Why do they say lower? If you have sovereign’s debt in one country that its currency is expected to appreciate (will pay higher interest) you will probably wait for new debt emissions with those expexted higher coupons. The current bonds you have will loose attractivity from the market and end up with higher yields, not lower…

Not sure what I am missing here…the assumption that the expected currency rise is linked with higher expected interest rates?

Well, once again, many thanks to you all.

tigas

#2

bond yields compensate investors for the risks taken, including currency risk. If the severely undervalued currency is expected to rise substantially, then currency risk (or risk that the currency will depreciate) is lower. hence the bond yield will be lower (assuming that the other risk factors are not affected). a stronger currency will not necessarily imply higher interest rates in future e.g. high expected inflation could lead to currency depreciation and higher interest rates in future (recall interest rate parity).

#3

Another way to look at it is to think that the “all-in yield” should be the same in both bonds. So, the yield you would get from the actual bond yield plus the yield from the expected currency appreciation should be the same for both bonds (I’m considering both bonds have the same risk).