Elementary Bond Question

[LaxFan]

I appreciate your efforts BMK--I'm just sticking to zero-coupon T-bills. I just don't get it.

I sometimes browse corporates yielding more than Treasuries and think maybe I should buy one, but I'm not trying to lose money with a bond.

I can't grasp the concepts of bonds (and it's frustrating). I think that's why average people stick to ETFs or some 60/40 mutual fund.

 

[BMK]

if not planning to hold until maturity (10 yrs is a long time to hold) we just want the price to go up to sell at a profit?

It may help if you explain why you are buying bonds. And I'm not trying to be funny.

So you bought a bond that matures in 10 years, and you are not planning to hold until maturity. Okay, that's fine. But what are you planning to do? What is your objective?

Do you want to hold the bond for a couple years and collect interest? Or are you betting on interest rates, hoping to sell the bond for a profit in a couple weeks (or a couple days, or a couple months)?

What are you trying to achieve?

If you buy a bond and hope to sell it a profit, then you are betting that interest rates are going to go down. If you are wrong, and interest rates go up, then the price of the bond will go down. You may take a loss when you sell the bond, but if you have held it long enough, that loss on the price of the bond may or may not be offset by the interest you have collected while you were holding the bond.

I think many people who want to bet on interest rate movements do indeed use something other than individual bonds, e.g., futures, or futures options, or ETFs.

 

[LaxFan]

It may help if you explain why you are buying bonds. And I'm not trying to be funny.

So you bought a bond that matures in 10 years, and you are not planning to hold until maturity. Okay, that's fine. But what are you planning to do? What is your objective?

Do you want to hold the bond for a couple years and collect interest? Or are you betting on interest rates, hoping to sell the bond for a profit in a couple weeks (or a couple days, or a couple months)?

What are you trying to achieve?

If you buy a bond and hope to sell it a profit, then you are betting that interest rates are going to go down. If you are wrong, and interest rates go up, then the price of the bond will go down. You may take a loss when you sell the bond, but if you have held it long enough, that loss on the price of the bond may or may not be offset by the interest you have collected while you were holding the bond.

I think many people who want to bet on interest rate movements do indeed use something other than individual bonds, e.g., futures, or futures options, or ETFs.

Collecting interest is the objective. But don’t want to get killed on the principal.

 

[BMK]

Collecting interest is the objective. But don’t want to get killed on the principal.

Then pick something that you can hold until maturity.

Six-month T-bills are currently paying almost five percent.

I am holding corporate bonds that mature in September 2024, and they have a yield to maturity of 6.434%. But they are not investment-grade bonds. They are not pure junk, but they have some real risk when compared to treasuries. They have a Moody's rating of Ba3.

If you are chasing yield, you may want to look at baby bonds or preferred stock.

Preferred stock is complicated because in some ways it behaves like a bond, and in some ways it behaves like stock. But it's not nuclear physics. And preferred shares are a lot more liquid and easy to trade than bonds.

You may private message me if you want.

 

[BMK]

Here's an example of another corporate bond we are holding. Rated Baa3 and BBB-, which is the bottom of the investment grade range. Maturity is January 2025. At the most recent market price, YTM is 5.66%.

 

[Real Money]

I appreciate your efforts BMK--I'm just sticking to zero-coupon T-bills. I just don't get it.

I sometimes browse corporates yielding more than Treasuries and think maybe I should buy one, but I'm not trying to lose money with a bond.

I can't grasp the concepts of bonds (and it's frustrating). I think that's why average people stick to ETFs or some 60/40 mutual fund.

Try to think about it like this. The bonds going down means that cash outperformed the security over the short term. In other words, by holding the asset, you took a risk that interest rates would not go up (and cash outperform the security).

It does not change your yield if held to maturity/redemption. But, it may reduce your funds performance relative to the guys who were holding more cash than you, or who hedged the risk with derivatives. Also, the guys that have foregone the hold (hedged their rate risk), and went to cash (while it outperformed) can now re-invest the money and get a higher return on it than was previously available.

The bond funds will roll their holdings over to match the prospectus investment objective (e.g. maintain average holding duration of X years, etc.) so the holders of the ETF are getting screwed even with the accruals.

The fund managers have hedges paying out and are diversified into cash/equities and so on.

 

[longandshort]

It’s good to start with first principles. When analyzing a bond there’s the price (how much am I paying for this bond?) and there’s the yield (what’s my return on this bond?). There are different types of yields that are calculated to tell you different things. The first yield (the yield when the bond is first issued) is often called the coupon rate, because in the old days, your bond certificate would have “coupons” you would cut off and bring to the bank to get paid.

So the first interest rate to know is the coupon rate. This is quoted as a % of par, for example, “5%”. What this means is that it pays $50 on a $1000 bond (“par” is the bond value and is typically $1000). For a bond you buy at issue or a treasury you buy at auction, the coupon rate is all that matters as it will match the other yields that are also calculated. What are these yields?

1) current yield. This yield takes the coupon payment and divides it by the current price of the bond. For example if the bond is trading below par, the current yield will be greater than the coupon rate. $50 on $950 is greater in % terms than $50 on $1000.

2) yield to call. Some bonds are “callable”, which means that the bond issuer can buy back all of the bonds between today and maturity, typically to get a better rate. Usually callable bonds will have a “noncallable” window where the bond can’t be called. For example, a 5yr callable bond might be non-callable for the first 2yr (guarantees first 2yrs at higher rate). Therefore, a yield to call is helpful to know what your yield is before the call can be done.

2) yield to maturity. This is the yield if you buy a bond in the secondary market and hold it to maturity. For example if you see a Ford bond that was originally issued as a 5yr paying 5%, currently trading with a yield to maturity of 6.5% with 3 years remaining… it means the bond has 3 years left, and that the price it’s trading for is below par.

3) yield to worst is the lower of yield to call, yield to maturity, and current yield.

Bond yields can be different things based upon when you buy them (relative to issuance date), what you buy them for (premium or discount to par), and the features they have (callable, etc.). Hope this helps.

 

[countryBoy641]

Here's an example of another corporate bond we are holding. Rated Baa3 and BBB-, which is the bottom of the investment grade range. Maturity is January 2025. At the most recent market price, YTM is 5.66%.

5.66% for a triple B ?
Treasury notes are still Triple A, 2 Year is 4.60 YTM on Friday (State tax exempt on accrual).
This is one of those markets where people think stocks and bonds are warm and fuzzy.
Then they turn around and bite you.
Just saying

 

[piezoe]

I understand that bond price/rates move in opposite directions. I've bought zero-coupon T-bills and held until maturity (i.e. 4.4% for a couple weeks/month). Simple.

You often hear about how someone could get a certain rate on the 2, 5, 10yr, or other types of bonds.

So, let's say I buy a bond that matures in 10 yrs. Of course I want the price to go up to make a profit (good). But then the interest rate goes down (bad). Do I receive less interest?

I hear commentators get excited when the rate goes up (i.e. "you can get 5% risk free!") If the rate goes up I get more interest (great), but the principal declines. I know I'm missing something..

So what do I want to happen if I buy a bond (and don't hold to maturity)?

"Getting Started in Bonds," S.S. Wright, 2nd Edition, 2003, John Wiley & Sons, Inc.
Available used in paper back on Amazon for $1.90 plus shipping. See Chapter 10 for worked out examples of the yield calculations for the various yields longandshort defined for you.

 

[LaxFan]

"Getting Started in Bonds," S.S. Wright, 2nd Edition, 2003, John Wiley & Sons, Inc.
Available used in paper back on Amazon for $1.90 plus shipping. See Chapter 10 for worked out examples of the yield calculations for the various yields longandshort defined for you.

Thanks for this recommendation.