Sallie Mae CPI-linked bonds

[haha]

How are you calculating yield?

I'm just using the moneychimp YTM calc, and assuming that par is $25 for both issues (but maturities differ). You don't need to make any assumptions about inflation, since both issues use the same coupon formula.

I use an excell function for accretion. ISM is cpi+2.05; OSM is CPI +2.00.

I disagree that it won' t matter what inflation is. Because you are buying either of these at a steep discount to par, your real current yield increases with CPI inflation and so therefore does the real YTM. I can't explain it very well, but if you make a spreadsheet I think you will see what I mean. If I had paid par, current nominal yield would be just inflation + 2.05% (ISM). Backing out inflation, you have just what you said-CPI +2.05%. regardless of the level of inflation.

However, since I paid 21.27, my nominal current yield is 25/21.27*(2.05+CPI). And my nominal YTM is this term +accretion of discount. So back out the nominal component, and anytime you buy below par you have real yield enhanced by (factor>1)*(cpi+2.05).

At least that is how I see it.

Ha

 

[wabmester]

I disagree that it won' t matter what inflation is. Because you are buying either of these at a steep discount to par, your real current yield increases with CPI inflation and so therefore does the real YTM.

Hmm, good point. You're getting the CPI at a discount too. But even in the case of 3.5% inflation, I'm still seeing a small YTM spread between the two issues (16bp instead of 11bp).

In any case, ISM looks like the better deal.

 

[justin]

Well, after watching the discussion unfold Friday, I decided ISM was a reasonably good bet short term and a low risk long term play, so I'm in for 500 shares at $21.33/share as of today. I figure based on 3.5% inflation going forward, I'll get 4.36% real return (yield to maturity) plus the 3.5% CPI return. A total annual return of 7.86% on an 11 year A-rated bond isn't too bad. If ISM shoots up to around 24 I can always sell and make a quick buck. Also, there's the potential arb play with OSM. Anyone else take advantage of this?

 

[wabmester]

I'll get 4.36% real return (yield to maturity) plus the 3.5% CPI return.

That real YTM seems high to me. How'd you come up with that number?

 

[brewer12345]

Well, after watching the discussion unfold Friday, I decided ISM was a reasonably good bet short term and a low risk long term play, so I'm in for 500 shares at $21.33/share as of today. I figure based on 3.5% inflation going forward, I'll get 4.36% real return (yield to maturity) plus the 3.5% CPI return. A total annual return of 7.86% on an 11 year A-rated bond isn't too bad. If ISM shoots up to around 24 I can always sell and make a quick buck. Also, there's the potential arb play with OSM. Anyone else take advantage of this?

That's pretty much my thoughts on the subject.

 

[haha]

That real YTM seems high to me. How'd you come up with that number?

Probably same way I did.

BTW, arbitrage is not so easy with the wide spreads and low volumes on these things.

Ha

 

[wabmester]

Probably same way I did.

That would be interesting if you're both getting the same number.

Brewer, what does Bloomberg print for the YTM?

 

[brewer12345]

Brewer, what does Bloomberg print for the YTM?

Depends on what you assume for inflation.

At 2% CPI, it is 5.877% YTM.
At 3%, it is 6.983%.
At 3.5%, it is 7.538%.
At 4%, it is 8.093%.

 

[wabmester]

That's what I get too. Ha and justin seem to be finding another 30bp from someplace.

 

[brewer12345]

That's what I get too. Ha and justin seem to be finding another 30bp from someplace.

I think we are beating around the bush, though. At roughly 175BP spread over similar TIPS, this is very attractive.

 

[wabmester]

I think we are beating around the bush, though. At roughly 175BP spread over similar TIPS, this is very attractive.

Oh, I agree they're a good deal -- I've been backing up the truck. I just don't think there's much of an arb play here, and there's no need to overstate the yield.

Assuming 0% inflation, the TIPS spread is more like 130bp. And we may well see a short period when inflation is pretty close to 0%. I think that's one reason why this issue is beat up, people may be looking at the paltry short-term yield.

Another benefit of ISM is that the lowest yield you'll get is 0%, even in periods of deflation. With TIPS, you'll lose some of the past inflation adjustment, giving them a negative yield.

 

[brewer12345]

Oh, I agree they're a good deal -- I've been backing up the truck. I just don't think there's much of an arb play here, and there's no need to overstate the yield.

Assuming 0% inflation, the TIPS spread is more like 130bp. And we may well see a short period when inflation is pretty close to 0%. I think that's one reason why this issue is beat up, people may be looking at the paltry short-term yield.

Another benefit of ISM is that the lowest yield you'll get is 0%, even in periods of deflation. With TIPS, you'll loose some of the past inflation adjustment, giving them a negative yield.

I expect that over the life of the security we will see CPI of at least 3% on average.

I keep an eye on PFK, which is of similar construction but a different issue. It has traded down, but doesn't offer as much yield at ISM. Fatter coupon, though.

 

[justin]

That real YTM seems high to me. How'd you come up with that number?

I see what you mean now. Maybe it is 7.56% for me (in at 21.33, and I'm assuming a 3.5% CPI). I got a nominal yield of 7.8% by calculating the YTM using real yields with the moneychimp.com calculator, then added the 17.2% "juice" I get on the CPI at 3.5% (since I bought at a discount to par), plus the 3.5% CPI. When I add the CPI plus the 2.05% spread, I get 5.55% yield on par, and after plugging into the moneychimp.com calculator, I get the 7.56% result. That is pobably the "correct" way to calc YTM! I'm a newbie to bond investing (this was my first one), but whether it is 7.5 or 7.8%, still not bad, all things considered. I was amazed at how low the liquidity was though.

 

[wabmester]

Several of you are estimating the yield using an assumed inflation rate of 3.5%.

I have no idea what inflation will be over the next 10 years, but if you must make a guess, I would use the market's guess.

The spread between 10-year TIPS and 10-year treasuries is 2.25%. So, the market is betting on inflation of just over 2% over the next 10 years.

At 2% inflation, the YTM on this issue would be 5.87%, and this has a bit more risk than a treasury.

I like ISM, because I want a hedge against *possible* inflation. But if you're looking at this as a high-yield play, you should compare that 5.9% YTM based on market-predicted inflation to the 6%+ CD's penfed is rumored to offer tomorrow.

 

[Nords]

BTW, arbitrage is not so easy with the wide spreads and low volumes on these things.

Judging from the comments of Wab, Brewer, et al, you guys are taking care of the market maker's problems all by yourselves...

 

[justin]

ISM - part inflation hedge, part speculation. If this thing jumps a few bucks in price, I'll probably sell and pocket the winnings. Worst case I hold it and it pays out between 5% and 8% over the next 11 years, depending on inflation.

The likely "worst case*" for me is still acceptable - hold to maturity.

Assuming Sallie mae doesn't go broke while I'm owning...

 

[wabmester]

I keep an eye on PFK, which is of similar construction but a different issue. It has traded down, but doesn't offer as much yield at ISM. Fatter coupon, though.

How do you find these? Most of the web quotes don't have much info on PFK, so I'll post this here for future reference:

Prudential Financial Inc., Inflation-Linked Retail Medium-Term Notes due 4/10/2018, and issued in $25 denominations. The notes are not redeemable prior to maturity and mature on 4/18/2018. Fixed rate distribtuions of 6.39% will be paid until 5/10/2006 after which variable inflation-linked distributions will be paid monthly on 10th calendar day of each month to holders of record on the record date which is not specified in the prospectus. The annual interest rate will be equal to the inflation-linked rate plus 2.40% but in no case will the annual interest rate be less than zero. The inflation index adjustment will be based on the percentage change in the U.S. Consumer Price Index (CPI) as defined in the prospectus. See page PS-3 of the prospectus for further information on the inflation-linked interest payments. The notes are expected to trade flat, which means accrued interest will be reflected in the trading price and the purchasers will not pay and the sellers will not receive any accrued and unpaid interest. The Notes are unsecured unsubordinated indebtedness of Prudential Financial and will rank equally with all existing and future unsecured and unsubordinated indebtedness of the company.

Par: $25
Matures: 4/10/2018
Moody/S&P: A3/A-

 

[brewer12345]

How do you find these?

Heheh, by looking. I like owning some individual bonds, but it is tough to do so as a retail investor, so I dig around and keep an eye on stuff that looks attractive and is exchenge traded or NYSE listed. www.quantumonline.com is invaluable for this.

 

[Dawg52]

Heheh, by looking. I like owning some individual bonds, but it is tough to do so as a retail investor, so I dig around and keep an eye on stuff that looks attractive and is exchenge traded or NYSE listed. www.quantumonline.com is invaluable for this.

Well keep digging. You save me the trouble of looking.

 

[justin]

Well keep digging. You save me the trouble of looking.

Seriously! It's a lot easier to do due diligence on a few individual issues when Brewer does all the heavy lifting for us by finding good prospects.