Careful with those Italian bond yields…

Italian bond yields reflect decisions announced at the 27 October EU summit — namely, that new Italian bond issues might carry first-loss insurance. If that’s the case, investors would rather hold those new bonds than the existing secondary market bonds. Which means there will be a wedge between the secondary market Italian bonds and the new issues. Check the yields on the latter before pronouncing on Italian sovereign debt sustainability.

Glossary: A bond yield tells you the return you get from buying the asset (the bond) and holding it till it matures. At that point, it pays the face value of the bond. En route, you will have also collected the ‘coupon’, or periodic interest payment, associated with the bond. So, there’s a principal repayment and an income stream, not unlike a bank loan. Here’s the catch: you can buy the asset for less than it’s face value. It should be obvious that the lower the price you have to pay to obtain the asset (the bond), the higher the total return to you. This is why bond prices and yields move inversely.

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