Sri Lanka Treasuries yields sharply up

sriranga · 1 Sri Lanka Treasuries yields sharply up Wed Nov 23, 2011 5:16 pm

sriranga

Co-Admin

Posts : 6822
Equity Stars : 23030
Reputation : 2855
Join date : 2011-02-01
Location : London

Nov 23, 2011 (LBO) - Sri Lanka's Treasuries yields rose steeply across maturities at Wednesday's auction with average one year yield touching 8.50 percent, data from the state debt office showed.

The six month yield rose 44 basis points to 7.95 percent and the 6-month yield rose 64 basis points to 8.18 percent.
The 12-month yield rose 91 basis points to 8.50 percent from two weeks earlier. Last week the debt office, which is a unit of the Central Bank rejected all offers.

The debt office said 3.0 billion rupees in 3-month bills were sold, 2.0 billion rupees in 6-month bills were sold and 3.0 billion in 12-month bills were sold.

Earlier in the day 3-month gilt repos traded around 8.50 percent dealers said.

There is uncertainty in Sri Lanka's bond markets following a devaluation announcement in the budget and liquidity has dried up with and no quotes for several maturities.

Following the auction there were quotes for a bond maturing in 2015 at around 10.25/11.00 percent, dealers said.
http://www.lbo.lk/fullstory.php?nid=838559150

Academic · 2 Re: Sri Lanka Treasuries yields sharply up Wed Nov 23, 2011 7:17 pm

Academic

Senior Manager - Equity Analytics

Posts : 454
Equity Stars : 5437
Reputation : 103
Join date : 2011-01-23

Not a good sign. Higher interest rate indicates higher inflation.

Higher inflation leads to low share valuation (P/E ratio).

To see this, consider following argument.

If inflation rate is I and company can pass Y percentage of inflation to customers (by increasing price), assuming full dividend payout (for simplicity), justified forward P/E ratio can be derived as follows.

Forward P/E= (1-b)/(r-b) , here r and b are nominal required rate of return and retention ratio.

Since assume full payout, b=0 and g=0. Thus

Forward P/E= 1/r

In an inflation, company's net earnings increase by Y*I rate. Therefore

Forward P/E= 1/(r-Y*I)

r is (approximately) the summation of real rate of return (RRR) and I. So

Forward P/E= 1/(rrr+I-Y*I)

=1/(rrr+I(1-Y).

Summary

When inflation increases justified P/E ratio decreases (increase downward pressure).
Companies/sectors that can pass inflation to customers should have higher P/E ratio than those who can't. In other words companies in highly competitive sectors would be severely affected.

nkalansu · 3 Re: Sri Lanka Treasuries yields sharply up Wed Nov 23, 2011 7:33 pm

nkalansu

Senior Manager - Equity Analytics

Posts : 335
Equity Stars : 5187
Reputation : 58
Join date : 2011-06-11
Age : 46

Academic wrote:
Not a good sign. Higher interest rate indicates higher inflation.

Higher inflation leads to low share valuation (P/E ratio).

To see this, consider following argument.

If inflation rate is I and company can pass Y percentage of inflation to customers (by increasing price), assuming full dividend payout (for simplicity), justified forward P/E ratio can be derived as follows.

Forward P/E= (1-b)/(r-b) , here r and b are nominal required rate of return and retention ratio.

Since assume full payout, b=0 and g=0. Thus

Forward P/E= 1/r

In an inflation, company's net earnings increase by Y*I rate. Therefore

Forward P/E= 1/(r-Y*I)

r is (approximately) the summation of real rate of return (RRR) and I. So

Forward P/E= 1/(rrr+I-Y*I)

=1/(rrr+I(1-Y).

Summary

When inflation increases justified P/E ratio decreases (increase downward pressure).

Companies/sectors that can pass inflation to customers should have higher P/E ratio than those who can't. In other words companies in highly competitive sectors would be severely affected.

Actually Higher Interest rates means ----------------->>>> Lower inflation. Not higher inflation

When interest rates are high people will deposit money at banks ------->>> less purchasing power (Low disposable funds)

When interest rates are high banks will increase lending rates---------->>> few loans (So low purchasing power, lower disposable funds)

So overall effect -------------->>> less demand for goods and services ------>>>> low inflation

So higher yield on TBills and TBonds means -------->>> Low inflation
Low yield on TBills and TBonds means --------->>> High inflation

Basically this is known as Monitory policy of Central Bank. That's how they use TBills and TBonds to control money supply to the economy and thereby control inflation.

Academic · 4 Re: Sri Lanka Treasuries yields sharply up Wed Nov 23, 2011 7:39 pm

Academic

Senior Manager - Equity Analytics

Posts : 454
Equity Stars : 5437
Reputation : 103
Join date : 2011-01-23

nkalansu wrote:

Academic wrote:
Not a good sign. Higher interest rate indicates higher inflation.

Higher inflation leads to low share valuation (P/E ratio).

To see this, consider following argument.

If inflation rate is I and company can pass Y percentage of inflation to customers (by increasing price), assuming full dividend payout (for simplicity), justified forward P/E ratio can be derived as follows.

Forward P/E= (1-b)/(r-b) , here r and b are nominal required rate of return and retention ratio.

Since assume full payout, b=0 and g=0. Thus

Forward P/E= 1/r

In an inflation, company's net earnings increase by Y*I rate. Therefore

Forward P/E= 1/(r-Y*I)

r is (approximately) the summation of real rate of return (RRR) and I. So

Forward P/E= 1/(rrr+I-Y*I)

=1/(rrr+I(1-Y).

Summary

When inflation increases justified P/E ratio decreases (increase downward pressure).

Companies/sectors that can pass inflation to customers should have higher P/E ratio than those who can't. In other words companies in highly competitive sectors would be severely affected.

Actually Higher Interest rates means ----------------->>>> Lower inflation. Not higher inflation

When interest rates are high people will deposit money at banks ------->>> less purchasing power (Low disposable funds)

When interest rates are high banks will increase lending rates---------->>> few loans (So low purchasing power, lower disposable funds)

So overall effect -------------->>> less demand for goods and services ------>>>> low inflation

Ok. Does that mean higher yield (high interest rate on Treasury bonds) signals our country is going to have lower inflation??? Can readers accept this line of argument?

Yield on a bond (market traded) implies required risk free rate (rf).

rf=(1+inflation)*(real rate of return+1)-1

So rf increases as inflation expectation increases.

Further, required rate of return on risky investments (RRRI) (e.g equity) is given by
=rf + risk premium

Thus, when rf increase due to inflation, RRRI increase. This decrease justified P/E ratio.

Last edited by Academic on Wed Nov 23, 2011 7:52 pm; edited 1 time in total

nkalansu · 5 Re: Sri Lanka Treasuries yields sharply up Wed Nov 23, 2011 7:46 pm

nkalansu

Senior Manager - Equity Analytics

Posts : 335
Equity Stars : 5187
Reputation : 58
Join date : 2011-06-11
Age : 46

To Academic

Actually this is theory. Economics.

When Government increase Tbills and Tbonds rates, what the Government does is borrowing locally. Government will absorb all the funds available. This will result in Banks have less funds to give loans. Which means people will have low disposable funds. Low money supply in the economy. So less demand for goods and services. Result is low inflation.

No arguments. This is Economic Theory.

nkalansu · 6 Re: Sri Lanka Treasuries yields sharply up Wed Nov 23, 2011 7:56 pm

nkalansu

Senior Manager - Equity Analytics

Posts : 335
Equity Stars : 5187
Reputation : 58
Join date : 2011-06-11
Age : 46

To Academic

That does not mean that our country is heading for low inflation. There are other factors that will trigger higher inflation.

Example------> Depreciation of rupee by 3%.
Basically our country is an import economy. Our imports are higher than exports. So what ever we import will cost more now because of rupee depreciation. Due to that we will have higher inflationary conditions. Our fuel will cost more now since we import it.

So there may be other factors that will create high inflation.

Not increasing interest rates on Tbills and Bonds.

Academic · 7 Re: Sri Lanka Treasuries yields sharply up Wed Nov 23, 2011 7:57 pm

Academic

Senior Manager - Equity Analytics

Posts : 454
Equity Stars : 5437
Reputation : 103
Join date : 2011-01-23

See I edited above post. I accept your economic theory. IMHO, the matter we have to resolve here is whether yield increase is due to increased inflation expectation or increased real return requirement. In my opinion it the former that triggered this.

I'm not an economist.

nkalansu · 8 Re: Sri Lanka Treasuries yields sharply up Wed Nov 23, 2011 8:03 pm

nkalansu

Senior Manager - Equity Analytics

Posts : 335
Equity Stars : 5187
Reputation : 58
Join date : 2011-06-11
Age : 46

Basically what I see is Government don't have money now. That's why they slowly increase rates of TBills and Tbonds and try to borrow locally. They have to find money to allocate funds to different departments and other govt. institutions as laid-down in the budget.

nkalansu · 9 Re: Sri Lanka Treasuries yields sharply up Wed Nov 23, 2011 8:07 pm

nkalansu

Senior Manager - Equity Analytics

Posts : 335
Equity Stars : 5187
Reputation : 58
Join date : 2011-06-11
Age : 46

If rates increase it is not good for the market. Because people will have a better time in investing in government Tbills/bonds and bank FDs. Not good timing for CSE.

Academic · 10 Re: Sri Lanka Treasuries yields sharply up Wed Nov 23, 2011 8:57 pm

Academic

Senior Manager - Equity Analytics

Posts : 454
Equity Stars : 5437
Reputation : 103
Join date : 2011-01-23

nkalansu wrote:Basically what I see is Government don't have money now. That's why they slowly increase rates of TBills and Tbonds and try to borrow locally.

If you compare gov's borrowings in last (23rd) tb auction with that of last months, you may realize that the borrowing has not been increased significantly.

See here http://www.cbsl.gov.lk/htm/english/_cei/ei/e_1.asp