Finance Minister Clyde Caruana turned a routine parliamentary question into a short lesson in bond pricing on Tuesday (yesterday), putting on his economist’s hat to put aside political rivalry and offer an apolitical explanation to Opposition MP Ivan Castillo on why some Malta Government Stocks (MGS) are currently trading at a significant discount.

Mr Castillo, an engineer by training and the Opposition spokesperson for maritime and employment, had asked why the price of MGS had fallen despite Malta’s continued economic growth.

In his reply, Minister Caruana explained that the price is “not necessarily affected by the general performance of Malta’s economy.”

He continued: “The most significant factor affecting the prices of MGS is the interest rate. When interest rates rise, existing bonds with lower yields become less attractive, so their price decreases.”

This inverse relationship between interest rates and bond prices is well illustrated in current market data. For instance, the 2.1 per cent MGS maturing in 2039 is trading at €81.31, significantly below its €100 face value. Similarly, the 1.6 per cent MGS maturing in 2032 is priced at €91.42.

In contrast, the 7 per cent MGS maturing in 2031 is commanding a premium, selling at €130.48.

The coupon rate [the interest generated over the nominal, or face-value, price] of a given fixed-income instrument can be more or less attractive depending on the broader interest rate environment.

Therefore, a bond – of any kind, including MGS – with a coupon rate of 3 per cent would be less attractive – and therefore cheaper – when general interest rates are above that level, as other investments will have a higher yield.

However, if interest rates go down below 3 per cent, then the same instrument with the same coupon rate of 3 per cent becomes more attractive – and more expensive.

The varying attractiveness of a given bond affects its price, which in turn affects its yield-to-maturity (YTM) – a key concept in bond investing. YTM measures the actual return an investor will earn if the bond is held until it matures, factoring in both its annual coupon and its market price.

For example, the 2.1 per cent MGS due in 2039, selling at €81.31, currently offers a YTM of 3.83 per cent. Meanwhile, the 7 per cent bond maturing in 2031, despite its high coupon, offers a lower YTM of 2.96 per cent due to its high purchase price.

This makes intuitive sense: investors demand a higher yield when their capital is tied up for longer, as in the case of the 2039 bond – a showcase of how the dynamics of supply and demand play out within the secondary market for MGS.