4. Adventures with convexity
Bond investors are notoriously risk-averse, and it's easy to see why. When you lend a borrower money, the best-case scenario is that they make good on their promise and pay you back. The worst-case scenario is you never get anything back, and lose all your money. The downside is always bigger than the upside.
Or nearly always.
Very long-dated bonds, like the 100-year bonds issued by Austria and Argentina in 2017, have a lot of convexity: They rise in price a lot when yields fall, more than they fall in price when yields rise. The result is that they can actually have more upside than downside.
Argentina's bond, naturally, has imploded as a debt restructuring has become inevitable. After rallying to a high of 103.60 in October 2017, it now trades at a highly-distressed level of less than 40 cents. At the same time, however, Austria's bond has soared in price as yields across the eurozone have fallen.
By the numbers: If you bought both bonds on the last day of February 2018, you would have paid $201.80. A year and a half later, at the end of August 2019, the combined bonds were worth $240.94, and you would also have received $13.84 in coupon payments in the interim.
- That's a total return of 26%, which is impressive for any bond investment, let alone one where half of the trade has plunged into distressed territory.