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Sallie Mae CPI-linked bonds
Old 12-18-2006, 03:46 PM   #1
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Sallie Mae CPI-linked bonds

I've been watching ISM and OSM ever since Brewer put them on my radar screen back in April. They tend to rise and fall together, but this month ISM took a dive (er, I mean, "went on sale").

I want to add more inflation indexed bonds to my allocation. Is there anything better than ISM out there now? My default choice is the Vanguard TIPS fund, but ISM looks inviting at this price. I'd appreciate any tips comments or pointers to other choices. Thanks.
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Re: Sallie Mae CPI-linked bonds
Old 12-18-2006, 03:49 PM   #2
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Re: Sallie Mae CPI-linked bonds

I don't see anything cheaper. All ears if anyone sees something.

Incidentally, Prudential issued PFK, a similar bond. Its not as good a deal as ISM, but it is worth watching.
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Re: Sallie Mae CPI-linked bonds
Old 12-18-2006, 08:48 PM   #3
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Re: Sallie Mae CPI-linked bonds

Thanks, Brewer, I really appreciate your posts.
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Re: Sallie Mae CPI-linked bonds
Old 12-18-2006, 10:52 PM   #4
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Re: Sallie Mae CPI-linked bonds

Any thoughts as to why it's trading so low ($21.35 at close 12-18)? The computed interest rate for all periods through 3/14/2007 is pretty low. And the inflation outlook seems benign. Anythng else come to mind?

Future interest rates (par basis) for ISM:

Dec 15 through Jan 14 = 4.11%

Jan 15 through Feb 14 = 3.35%

Feb 15 through Mar 14 = 4.02%

Your actual rate = $25/your price X the above rates.


edited to fix date.
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Re: Sallie Mae CPI-linked bonds
Old 12-19-2006, 06:40 AM   #5
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Re: Sallie Mae CPI-linked bonds

YTM for ISM is about 4% over inflation. Since 10 year TIPS are trading around 2.25% over inflation, that means you are being offered 1.75% a year to take credit risk from a single A credit. This is an absurdly high number.

So why are we being offered this very good deal? I don't think we can definitively point to anything obvious. My personal theory is that it is a small issue ($75MM total) owned mostly by clueless retail investors who don't understand what they bought and are selling because the yield is temporarily falling without ever bothering to look at the TIPS market.
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Re: Sallie Mae CPI-linked bonds
Old 12-19-2006, 10:21 AM   #6
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Re: Sallie Mae CPI-linked bonds

Quote:
Originally Posted by brewer12345
My personal theory is that it is a small issue ($75MM total) owned mostly by clueless retail investors who don't understand what they bought and are selling because the yield is temporarily falling without ever bothering to look at the TIPS market.
I agree with that logic for a lot of investments.

So much for the efficient market hypothesis... we need an "irrational investor hypothesis".
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Re: Sallie Mae CPI-linked bonds
Old 12-19-2006, 10:33 AM   #7
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Re: Sallie Mae CPI-linked bonds

All of the corp/muni floaters that I have solicited bids for recently have come back with really low bids. When the coupon drops 1.76% over a month they are going to be harder for bond desks to market, especially to retail investors. CIT has several floaters (ex. 12560PDK4) also A rated. In case anyone wants to know ISM is a Sallie Mae baby bond which means that it trades on an exchange at a par value under 1000 which is standard for normal bonds. The par for ISM is 25. Baby bonds can trade at a discount or premium to their 1000/ peers.
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Re: Sallie Mae CPI-linked bonds
Old 12-19-2006, 11:13 AM   #8
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Re: Sallie Mae CPI-linked bonds

Quote:
Originally Posted by brewer12345
YTM for ISM is about 4% over inflation. Since 10 year TIPS are trading around 2.25% over inflation, that means you are being offered 1.75% a year to take credit risk from a single A credit. This is an absurdly high number.

So why are we being offered this very good deal? I don't think we can definitively point to anything obvious. My personal theory is that it is a small issue ($75MM total) owned mostly by clueless retail investors who don't understand what they bought and are selling because the yield is temporarily falling without ever bothering to look at the TIPS market.
I probably fall into the clueless ranks but I have broken out of it to some extent. In fact, I just bought a little more of ISM.
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Re: Sallie Mae CPI-linked bonds
Old 12-19-2006, 01:43 PM   #9
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Re: Sallie Mae CPI-linked bonds

ISMs are new to me. From the discussion, they seem like private versions of inflation adjusted bonds. Where can I find out more about them?
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Re: Sallie Mae CPI-linked bonds
Old 12-19-2006, 01:45 PM   #10
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Re: Sallie Mae CPI-linked bonds

Quote:
Originally Posted by Independent
ISMs are new to me. From the discussion, they seem like private versions of inflation adjusted bonds. Where can I find out more about them?
If you search he forum you will find links to the prospectus.
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Re: Sallie Mae CPI-linked bonds
Old 12-19-2006, 02:22 PM   #11
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Re: Sallie Mae CPI-linked bonds

Quote:
Originally Posted by brewer12345
So why are we being offered this very good deal? I don't think we can definitively point to anything obvious. My personal theory is that it is a small issue ($75MM total) owned mostly by clueless retail investors who don't understand what they bought and are selling because the yield is temporarily falling without ever bothering to look at the TIPS market.
I agree that this is likely. The chance that the selling is rational and information based IMO is made even less likely by the opposite market gyrations of OSM, which depending on price is essentially equal.

For years I have seen this kind of behavior with oil royalty trusts. Occasionally there may be a chargeback from the lease operator, which requires that royalty payments to the trust be suspended for some definite period. This leads to investor payouts being lowered or cancelled, again for some known usually short period. Invariably, this kills the price of the royalty units, causing much greater market value depreciation than the total of the chargebacks. Then after full payouts have been restored, back up comes the price.

Makes you wonder who is home in investorland.

Ha
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Re: Sallie Mae CPI-linked bonds
Old 12-19-2006, 02:33 PM   #12
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Re: Sallie Mae CPI-linked bonds

Brewer, I believe you said in another post that you had once looked at shorting OSM's against ISM's (or maybe it was the reverse) but that you couldn't borrow the security. In any case, why wouldn't investors who are long OSM sell and replace it with ISM as this would not require a short sale. Why isn't this happening now? I would think brokers would be calling their clients to get them to do this trade.
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Re: Sallie Mae CPI-linked bonds
Old 12-19-2006, 02:40 PM   #13
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Re: Sallie Mae CPI-linked bonds

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Originally Posted by FIRE'd@51
I would think brokers would be calling their clients to get them to do this trade.

Hahahahahahahaha!!!

Don't bet on it. Maybe sell ISM/OSM and buy the latest junk bond offering...

But the trade you mention is exactly what I did for my FIL today.
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Re: Sallie Mae CPI-linked bonds
Old 12-19-2006, 07:14 PM   #14
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Re: Sallie Mae CPI-linked bonds

Quote:
Originally Posted by brewer12345
YTM for ISM is about 4% over inflation. Since 10 year TIPS are trading around 2.25% over inflation, that means you are being offered 1.75% a year to take credit risk from a single A credit. This is an absurdly high number.
Hi Brewer, where do you find the YTM for ISM? Thanks.
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Re: Sallie Mae CPI-linked bonds
Old 12-19-2006, 07:24 PM   #15
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Re: Sallie Mae CPI-linked bonds

Quote:
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Hi Brewer, where do you find the YTM for ISM? Thanks.
I look at the yield calculation on my Bloomberg terminal.
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Re: Sallie Mae CPI-linked bonds
Old 12-19-2006, 07:33 PM   #16
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Re: Sallie Mae CPI-linked bonds

Quote:
Originally Posted by brewer12345
I look at the yield calculation on my Bloomberg terminal.
Hmm, ok, slightly different question: How do us mere mortals access this information?
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Re: Sallie Mae CPI-linked bonds
Old 12-20-2006, 01:16 AM   #17
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Re: Sallie Mae CPI-linked bonds

Quote:
Originally Posted by WanderALot
Hmm, ok, slightly different question: How do us mere mortals access this information?
You can use a calculator at this site to determine YTM: http://www.moneychimp.com/

Click on "calculator" then choose "bond yield"

You'll need to know current market price (or the price you're interested in determining the YTM from), par, coupon and time to maturity.

For ISM, with a current price of 21.35, par of 25, coupon of 2.05% and time to maturity of 11.1 years, YTM is just under 3.7% plus year to year percentage change in cpi.

You can calculate future yields for ISM out three months by going to www.bls.gov and going to the consumer price index - all urban consumers. ISM uses the index from three months prior to calculate this months rate. This information and the formula for calculating rates is in the prospectus and I posted the Dec 15, Jan 15 and Feb 15 information on this thread yesterday.

Hope this helps.

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Re: Sallie Mae CPI-linked bonds
Old 12-20-2006, 07:44 AM   #18
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Re: Sallie Mae CPI-linked bonds

Youb is pretty much spot on. One additional point is that if you buy a CPI-linked note at a discount to par, there is a CPI multiplier effect. So if par is 25 and you buy at 21.50, you get the spread plus CPI times 25/21.5 or CPI X 1.16.
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Re: Sallie Mae CPI-linked bonds
Old 12-20-2006, 08:18 AM   #19
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Re: Sallie Mae CPI-linked bonds

Quote:
Originally Posted by brewer12345
Youb is pretty much spot on. One additional point is that if you buy a CPI-linked note at a discount to par, there is a CPI multiplier effect. So if par is 25 and you buy at 21.50, you get the spread plus CPI times 25/21.5 or CPI X 1.16.
Yep, as brewer said. And examples of these are calculated in a post I made earlier in this thread.

BTW, ISM has been an interesting learning experience as I had never purchased this type of security before but found both the prospectus and pricing supplement to be easy to read and fairly straightforward.

After learning to do the numbers, I'm now trying to understand the different methodology in payout between TIPS and ISM. TIPS adds the inflation component to the prinicapal and pays the coupon interest X the rising principal to you. ISM calculates a rate based on current cpi minus twelve month prior cpi plus 2.05%, multiplies that by par and pays that to you. I'm not sure which is more beneficial.....or if it matters......
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Re: Sallie Mae CPI-linked bonds
Old 12-20-2006, 08:22 AM   #20
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Re: Sallie Mae CPI-linked bonds

Youb, in another thread, we actually found out that the TIPS funds out there actually liquidate (or use STRIPS) and pay out the inflation adjustment. That being the case, they work just like ISM/OSM/PFK, and not like the underlying TIPS.
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