Real versus Nominal Returns.
Do you think it is possible for risk-free Treasury bills to offer a negative nominal interest rate? Might they offer a negative real expected rate of return?
For conventional treasuries, the answer to the first question is no. People would just keep cash instead.
A different situation applies to Treasury Inflation Protected Securities (TIPS). They often trade above face value and with almost zero yield. People are willing to pay a premium for inflation protection, but usually this is done by paying more for the TIPS bond than its face value.
As for your second question, the answer is yes. Many US bond funds have been struggliong to provide a positive return lately, as yields were low and bond values were falling.
To understand the concepts of real versus nominal returns, let's break it down:
- Nominal returns refer to the percentage increase or decrease in the value of an investment, without considering the effects of inflation.
- Real returns, on the other hand, take into account the impact of inflation on the purchasing power of your investment. It measures the actual increase or decrease in your wealth after adjusting for inflation.
Now, let's address your specific questions:
1. Risk-Free Treasury Bills Offering Negative Nominal Interest Rates:
For conventional treasury bills, it is generally not possible for them to offer a negative nominal interest rate. This is because if the interest rate on treasury bills were negative, it would mean that an investor would have to pay the government for the privilege of lending them money. In such a scenario, individuals and investors would prefer to hold cash rather than investing in treasury bills.
2. Risk-Free Treasury Bills Offering Negative Real Expected Rate of Return:
While it is unlikely for conventional treasury bills to offer negative real expected rates of return, there is a different situation for Treasury Inflation Protected Securities (TIPS). TIPS are specifically designed to protect investors from inflation. They typically trade at a premium above their face value and often have very low or even negative nominal yields. The reason people are willing to pay a premium for TIPS is because they provide protection against inflation, and the returns on TIPS are adjusted for inflation.
Regarding your second question, it is possible for investments like bond funds to offer a negative real return. This can occur when the yield on the bond investments is low, and the value of the bonds themselves is falling. When bond values decrease, it can erode the potential returns and lead to a negative real return, especially if inflation is outpacing the returns from the bonds.
Overall, when evaluating investments, it is important to consider both the nominal and real returns to have a comprehensive understanding of how they will impact your wealth and purchasing power over time.