The increase in the Greek stock market this past week is an indication that foreign investors have returned to this particular market. The question is why when the country is amid an economic crisis.
The answer is that hedge funds are buying stocks because bond spreads have declined to 883 basis points, while bond returns are at 10.5%. When valuing a bond, there is an inverse relationship between prices and interest rates. When bond prices go up interest rates go down, and this is due to the fact that there is a higher demand for bonds, which has turned the hedge funds away from the bond market into the stock market.
At this time the 10 years Greek bonds are close to a 9% return, and hedge funds and investment banks have turned to the Greek stock market.
Bonds which are issued by either corporations or governments do so to issue debt in order to finance various financial activities. Bonds are mainly interest only loans with the borrower paying interest every period, and the principal at the end of the loan, or maturity. The interest payments are called the bond’s coupons, while the amount paid at the end of the loan is the bond’s face value or par.
We know that interest rates are change but the cash flows from a bond stay the same. This will cause the value of the bond to fluctuate. When interest rates increase, the present value of the bond’s remaining cash flows decrease and the bond is worth less. When interest rates decline, the bond is worth more.
A bond spread is the difference between the yields of two bonds with different credit ratings. When Greek bonds were almost considered as junk bonds, this difference (Greek and the German benchmark) was skyrocketing. That was when many hedge funds were betting that Greece would default (beginning 2012 and even earlier), and were hedging thus making huge profits, some. The bond spread would show the additional yield that could be earned from bonds with higher risk.
