When pension funds calculate the value of their liabilities, they therefore use a bond yield to discount future payments.
Private plans' use of a bond-based discount rate reflects that higher equity returns are not a free lunch--the firm will be required to cough up extra cash if the assets underperform.
To this end we invite Greece, private investors and all parties concerned to develop a voluntary bond exchange with a nominal discount of 50% on notional Greek debt held by private investors.
The investment grade rated bond eventually sold at a slight discount from par and fetched a yield of 4.5%, over 250 basis points over 10 year U.S. Treasury bonds.
Currently, we are using a 10-year Treasury bond yield of 6% as a discount rate.
Cynics might argue that various accounting and solvency regulations that encourage pension funds to discount their liabilities by the government-bond yield have created a handy incentive for pension funds to invest in government bonds.
As a callow bond-trader, fresh out of college, he participated in one of the greatest of them all, in Japan in 1986, when the yield on the ten-year benchmark Japanese government bond fell to 2.5%, the discount rate at the time.
It calculates an intrinsic value by discounting a stream of future earnings back to the present, using a discount rate that is a function of both Aaa bond yields and the creditworthiness of the target company.
Junk bond funds are yielding north of 7% and trading at a discount to boot.
In 1994 the discount rate was raised four times prompting investors to flee bond funds en masse (see graph below).
Say the rate on the Spanish bond was 5% and Corzine was able to purchase at a 10% discount to par (100) or 90% of face value.
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If you assume that the bond is selling at par, has an average coupon of 5.5%, say, and you use a discount rate of 6%, then you are implicitly saying that the bond is actually riskier than the market perceives it to be.
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Just over a week after that statement, the Fed abruptly turned course, cutting the discount rate to encourage bank borrowing to ease a growing liquidity crisis in the credit and bond markets.
Buy a bond backed by an aging 747 or 767 and you could find even 40% isn't enough of a discount.
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