Credit deflation and the reflation cycle to come.

[Thorn]

40 minutes ago, Castlevania said:

What are your lots thoughts on Political risk? I just read this article (infomercial)  https://www.telegraph.co.uk/investing/funds/43bn-global-fund-manager-brazilian-government-screwed-one-investments/?li_source=LI&li_medium=li-recommendation-widget on the Torygraph website but found this quote interesting

 

 

So, what’s the likelihood of a UK government in the midst of a reflation tapping up your SSE’s; National Grid’s or Centrica’s for example?

High.

And it’s been done before. 

Next thing is what price per share gets agreed as Fair Value.

[Democorruptcy]

On 02/07/2018 at 14:57, Inoperational Bumblebee said:

This explanation makes perfect sense to me if they are short EUR (or other non-USD) bonds but long USD in 'company' denomination (terms may be clumsy but hopefully it'll make sense). It's effectively a carry trade that would reduce the overall EUR bond interest rate. If money floods to the USD in the event of a crash as DB is suggesting, then they'll be quids in via exchange rate too!

It's effectively the same thing we're trying to achieve by buying TLT/IBTL, but in reverse as it's debt.
I think it's a huge positive to take from that. We are doing the same trade that they've bet whopping amounts on.
It's interesting to note how little of the debt on DB's shelf trade link is USD-denominated.

I emailed Vodaphone Investor Relations and they replied today:
 

Quote

 

The tiered rates are all US$ denominated rates

In contrast the 2% number is the euro equivalent interest rate once we have swapped the USD proceeds into euro using cross currency swaps. 

So we trade derivatives which essentially convert the USD debt into EUR debt and the effective cost is 2% in euro terms. Essentially the percentage cost in euros is lower taking into account expected movements in currencies over the life of the bond.

 

 

[Thorn]

1 hour ago, Thorn said:

High.

And it’s been done before. 

Next thing is what price per share gets agreed as Fair Value.

Check out Robb Caledon  renationalisation 1976

[Castlevania]

29 minutes ago, Democorruptcy said:

I emailed Vodaphone Investor Relations and they replied today:
 

 

I was correct!

[Bear Hug]

51 minutes ago, Democorruptcy said:

I emailed Vodaphone Investor Relations and they replied today:
 

Good work! You, and Vodafone!

[Thorn]

21 minutes ago, Bear Hug said:

Good work! You, and Vodafone!

Bloody amazing Castlevania, Democorruptcy.

Bloody brilliant thread.

[Inoperational Bumblebee]

1 hour ago, Democorruptcy said:

I emailed Vodaphone Investor Relations and they replied today:

Thanks! Feeling vindicated. 

[MrXxx]

14 hours ago, leonardratso said:

the new victorian slums, except the victorian slums were built to last.

Well look on the bright side, they will either fall down or be knocked down in the next 30~50 years, and thus remove this sub par accommodation from the housing stock :_)

[Band]

Good show on boom bust show on RT about the lack of infrastructure spending in the USA over the last 4 decades. Trump stating their airports are 3rd world.

[DurhamBorn]

11 hours ago, Democorruptcy said:

I emailed Vodaphone Investor Relations and they replied today:
 

 

Thats fantastic,perhaps Bumblebee and Castlevania can write a post in easy to understand language about how that works,its worth having on the thread i think for everyone.

So the debt costs are 2%.

[DurhamBorn]

59 minutes ago, Banned by HPC said:

Good show on boom bust show on RT about the lack of infrastructure spending in the USA over the last 4 decades. Trump stating their airports are 3rd world.

Yep,their water systems,bridges,airports all need investment.China will have to hugely push its one belt one road just as the west has an upgrading infrastructure cycle.On top of the upgrades there will also be massive investment in green energy/telcos etc.Wealth creation cycle that we feel will overheat with very high rates being the end game.

[Band]

5 minutes ago, DurhamBorn said:

Yep,their water systems,bridges,airports all need investment.China will have to hugely push its one belt one road just as the west has an upgrading infrastructure cycle.On top of the upgrades there will also be massive investment in green energy/telcos etc.Wealth creation cycle that we feel will overheat with very high rates being the end game.

Did you see the show? Told us what we already know but good to see it on MSM if RT is classed as MSM.

Said there telco infrastructure was poor also.

 pt1

https://www.rt.com/shows/boom-bust/431873-infrastructure-economy-markets-spending/

 pt2 

https://www.rt.com/shows/boom-bust/432077-infrastructure-us-future-things/

[DurhamBorn]

2 minutes ago, Banned by HPC said:

Did you see the show? Told us what we already know but good to see it on MSM if RT is classed as MSM.

Said there telco infrastructure was poor also.

 

Think this is pt1

https://www.rt.com/shows/boom-bust/431873-infrastructure-economy-markets-spending/

Here it is pt2 anyway

https://www.rt.com/shows/boom-bust/432077-infrastructure-us-future-things/

Thats great il watch that tomorrow.The whole of the west will be similar.

[Castlevania]

2 hours ago, DurhamBorn said:

Thats fantastic,perhaps Bumblebee and Castlevania can write a post in easy to understand language about how that works,its worth having on the thread i think for everyone.

So the debt costs are 2%.

I’ll try. It broadly works like this (using as an example borrowing $100m for 10 years).

1. Issue $100m of 10 year bonds at 4.5%. Vodafone now have $100m in cash.

2. Enter into a 10 year EURUSD cross currency swap with a bank. 

Cross currency swaps involve exchanging notionals at the outset. So Vodafone hands over the $100m they just borrowed from the bond investors to the bank, who in turn hand Vodafone ~€85m at current exchange rates. Vodafone now have €85m in cash. 

For the duration of the cross currency swap Vodafone will pay the prevailing interest rate on €85m and in turn receive the prevailing interest rate on $100m.

As a proxy for this example let’s use the 10yr German bund yield for the € rate and the 10yr US Treasury yield for the $ rate.

The 10yr Bund yields ~0.3% whilst the 10yr Treasury yields ~2.8%. So Vodafone pay 0.3% on €85m (€255k a year) and in turn receive 2.8% on $100m ($2.8m).

Vodafone will then use the $2.8m from the  USD leg to pay part of the 4.5% coupon on their bonds. So effectively have reduced their net borrowing cost to ~2% in €.

Hopefully the above shows how they can effectively reduce their borrowing costs by ~250basis points by entering into the cross currency swap. 

3. After 10 years, the cross currency swap will mature. Vodafone will hand back the €85m to the bank and receive $100m.

4. Vodafone will then hand back the $100m to the bond investors.

Simples.

 

 

 

[reformed nice guy]

45 minutes ago, Castlevania said:

I’ll try. It broadly works like this (using as an example borrowing $100m for 10 years).

1. Issue $100m of 10 year bonds at 4.5%. Vodafone now have $100m in cash.

2. Enter into a 10 year EURUSD cross currency swap with a bank. 

Cross currency swaps involve exchanging notionals at the outset. So Vodafone hands over the $100m they just borrowed from the bond investors to the bank, who in turn hand Vodafone ~€85m at current exchange rates. Vodafone now have €85m in cash. 

For the duration of the cross currency swap Vodafone will pay the prevailing interest rate on €85m and in turn receive the prevailing interest rate on $100m.

As a proxy for this example let’s use the 10yr German bund yield for the € rate and the 10yr US Treasury yield for the $ rate.

The 10yr Bund yields ~0.3% whilst the 10yr Treasury yields ~2.8%. So Vodafone pay 0.3% on €85m (€255k a year) and in turn receive 2.8% on $100m ($2.8m).

Vodafone will then use the $2.8m from the  USD leg to pay part of the 4.5% coupon on their bonds. So effectively have reduced their net borrowing cost to ~2% in €.

Hopefully the above shows how they can effectively reduce their borrowing costs by ~250basis points by entering into the cross currency swap. 

3. After 10 years, the cross currency swap will mature. Vodafone will hand back the €85m to the bank and receive $100m.

4. Vodafone will then hand back the $100m to the bond investors.

Simples.

 

 

 

Thank you for the clear explanation.

Can I ask - if there is a significant change in exchange rates, could this either be very good or very bad for Vodafone in this set up?

[Castlevania]

19 minutes ago, reformed nice guy said:

Thank you for the clear explanation.

Can I ask - if there is a significant change in exchange rates, could this either be very good or very bad for Vodafone in this set up?

Not really. Most of their revenues are in € so it makes sense to pay their debts in € which through the cross currency swap allows them to do so. 

If they hadn’t entered into the cross currency swap they’d be exposed to the EURUSD exchange rate, so if the € weakens ($ strengthens) they’d have to pay in € terms more in interest and more when repaying the bond. 

However, they could have got around this by issuing € denominated bonds. Not quite sure why they didn’t go down this route. I assume that it must have worked out cheaper to issue $ denominated bonds and enter into a cross currency swap.

EDIT: although they are exposed to a number of currencies through their global operations. The plunge in the value of the Turkish Lira since the start of the year for example, is bound to hurt their revenues.

[Funn3r]

Fascinating and I came very close to understanding it. My question is how come everyone in the euro zone and their pet dog don't instantly ditch their 0.3% -paying German bonds and instead buy the 2.8% -paying American ones? 

[Inoperational Bumblebee]

9 hours ago, DurhamBorn said:

Thats fantastic,perhaps Bumblebee and Castlevania can write a post in easy to understand language about how that works,its worth having on the thread i think for everyone.

So the debt costs are 2%.

 

7 hours ago, Castlevania said:

I’ll try. It broadly works like this (using as an example borrowing $100m for 10 years).

1. Issue $100m of 10 year bonds at 4.5%. Vodafone now have $100m in cash.

2. Enter into a 10 year EURUSD cross currency swap with a bank. 

Cross currency swaps involve exchanging notionals at the outset. So Vodafone hands over the $100m they just borrowed from the bond investors to the bank, who in turn hand Vodafone ~€85m at current exchange rates. Vodafone now have €85m in cash. 

For the duration of the cross currency swap Vodafone will pay the prevailing interest rate on €85m and in turn receive the prevailing interest rate on $100m.

As a proxy for this example let’s use the 10yr German bund yield for the € rate and the 10yr US Treasury yield for the $ rate.

The 10yr Bund yields ~0.3% whilst the 10yr Treasury yields ~2.8%. So Vodafone pay 0.3% on €85m (€255k a year) and in turn receive 2.8% on $100m ($2.8m).

Vodafone will then use the $2.8m from the  USD leg to pay part of the 4.5% coupon on their bonds. So effectively have reduced their net borrowing cost to ~2% in €.

Hopefully the above shows how they can effectively reduce their borrowing costs by ~250basis points by entering into the cross currency swap. 

3. After 10 years, the cross currency swap will mature. Vodafone will hand back the €85m to the bank and receive $100m.

4. Vodafone will then hand back the $100m to the bond investors.

Simples.

Near enough for me, though if you understand how bonds work already, I'd just say the exchange rate effect on the interest rate is simply calculated by:
[bond interest rate]+[ECB base rate]-[Fed base rate]
because you pay interest on money you borrow (first two), but earn interest on money you have (latter).

@Castlevania or anyone else for that matter, do you think they'd fix the exchange rate for the bond period (as CV has suggested), or just let it float? I reckon they'd let it float myself...

6 hours ago, reformed nice guy said:

Thank you for the clear explanation.

Can I ask - if there is a significant change in exchange rates, could this either be very good or very bad for Vodafone in this set up?

Depends on the answer to my question immediately above. If fixed for the bond period, then there will be no effect whatsoever.

If floating, then if the dollar gets stronger then this is good for Vodafone (and vice versa). As mentioned previously, those of us doing the IBTL/TLT play are effectively doing the same thing.

What would affect things more is the differential between US and ECB base interest rates, though even if the gap lessened I suspect exchange rate effects would considerably dampen or outweigh this.

[Inoperational Bumblebee]

2 hours ago, Funn3r said:

Fascinating and I came very close to understanding it. My question is how come everyone in the euro zone and their pet dog don't instantly ditch their 0.3% -paying German bonds and instead buy the 2.8% -paying American ones? 

Because the US is already engaging on a program of raising rates which would drop capital values of bonds, whereas the ECB are rather convincingly doing sod all. It's return of your money, rather than return on your money that is in the back of people's minds.

[Bear Hug]

10 hours ago, Castlevania said:

The 10yr Bund yields ~0.3% whilst the 10yr Treasury yields ~2.8%. So Vodafone pay 0.3% on €85m (€255k a year) and in turn receive 2.8% on $100m ($2.8m).

I don't understand currency forward rates that well but this appear to be consistent with 

https://uk.investing.com/currencies/eur-usd-forward-rates

EURUSD 10Y FWD

Bid: 2928.0000

Ask: 2968.0000

Presumably above are in bps.. so if current EUROUSD exchange rate is 1.17, does it meant that expected EuroUSD rate in 10 years is 1.17 + ~30% = 1.47 (i.e. 1 Euro will be 1.47 USD in 10 years) ?

 

[King Penda]

3 hours ago, Inoperational Bumblebee said:

Because the US is already engaging on a program of raising rates which would drop capital values of bonds, whereas the ECB are rather convincingly doing sod all. It's return of your money, rather than return on your money that is in the back of people's minds.

in the event of a bail in are bonds safe ?

[Inoperational Bumblebee]

50 minutes ago, stokiescum said:

in the event of a bail in are bonds safe ?

Well, that's the multi-trillion dollar question. This is complicated by there not being 'euro bonds' but rather individual country bonds. I'd be a lot more comfortable with German bonds rather than any from say Italy or Greece, but I believe they are ultimately they are all underwritten by the ECB. If you've watched recent Greek shenanigans, you'll know what I'm getting at.

Given that the Fed underwrites the US, and the ECB underwrites everyone in the eurozone, I personally have a lot more confidence in US bonds. The way I look at it, what's more likely, the US defaults on its debt, or the eurozone falls apart? I have put my money where my mouth is.

[Inoperational Bumblebee]

Have no doubt though, if either happens,  all hell is likely to break loose. IMO it's a trade-off; it is a risk, but other things will be far more pressing if this situation does occur.

You'll be far more concerned about losing everything you hold dear, including your life. I would like to think this is a rather unlikely situation.

[King Penda]

12 minutes ago, Inoperational Bumblebee said:

Well, that's the multi-trillion dollar question. This is complicated by there not being 'euro bonds' but rather individual country bonds. I'd be a lot more comfortable with German bonds rather than any from say Italy or Greece, but I believe they are ultimately they are all underwritten by the ECB. If you've watched recent Greek shenanigans, you'll know what I'm getting at.

Given that the Fed underwrites the US, and the ECB underwrites everyone in the eurozone, I personally have a lot more confidence in US bonds. The way I look at it, what's more likely, the US defaults on its debt, or the eurozone falls apart? I have put my money where my mouth is.

china might have a part to play in this,what if people stop buying american debt ? unfair questions i know

[Inoperational Bumblebee]

17 minutes ago, stokiescum said:

china might have a part to play in this,what if people stop buying american debt ? unfair questions i know

Then interest rates will rise. I still think US debt will be the safe haven though, so as before, interest rate rises will be offset by exchange rate effects.