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Re: Seems ISM is taking a bit of a beating this week...
Old 02-24-2007, 01:04 PM   #21
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Re: Seems ISM is taking a bit of a beating this week...

Quote:
Originally Posted by Cute Fuzzy Bunny
You're buying dollars for 84c and at normal levels of inflation you're getting paid like a very decent 5 year CD while you hold it. At higher levels of inflation, even better.

My entire cash position right now is divided between penfed 5 and 7 year 6.25% cd's and ISM.
I can't wait until it goes to $24.75. Then we will be beating the crap out one another to get out, spreading disinformation on the board, etc. .

Ha
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Re: Seems ISM is taking a bit of a beating this week...
Old 02-24-2007, 04:20 PM   #22
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Re: Seems ISM is taking a bit of a beating this week...

Interesting little security. I am correct in assuming that this exactly the same as a TIPs bond trading at 14% discount to par. Other than the fact there is a very slight default riska of Sallie Mae going out of business.

Anyone calculated a YTM on this guy. It looks like assuming a 3% inflation rate that is just under 7%.

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Re: Seems ISM is taking a bit of a beating this week...
Old 02-24-2007, 08:40 PM   #23
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Re: Seems ISM is taking a bit of a beating this week...

Quote:
Originally Posted by clifp
Interesting little security. I am correct in assuming that this exactly the same as a TIPs bond trading at 14% discount to par.
Not quite. For one thing, the returned principal is exactly $25, regardless
of inflation; so dependng on whether inflation over the next 11 years is
greater/less than 1.6% annually, the principal will under-/out-pace inflation
(since the 11th-root of 25/21 = 1.016). TIPS exactly matches inflation.

For another, the coupon is only 2.05%, not 2.375%. And it's added to inflation
over the last year. TIPS is added to the cumulative inflation since you bought the
thing. So ISM is probably doing better until the cumulative inflation hits 25/21,
and worse afterwards. And ISM is kinda looking at the derivative of inflation, not
the integral. If inflation spikes one year and then becomes low, ISM pays great
dividends during that year, and then not so good; whereas TIPS pays based on
the inflated principal from then on.

Yes, the YTM calculator gives a better number for ISM. But that's because it
gives a number based on zero inflation, with the hand-waving statement that
this is "real yield" (yield above infaltion). Problem is, in the real world where
inflation exists and is probably more than 1.6% on average, inflation adds more
to the TIPS' value than to ISM's. In other words, TIP's yield is "more real"
than ISM's.

That's not to say ISM sucks - it's probably a good diversification of one's inflation-linked
fixed-income holdings (I have about 7% of my FI there now) - just that I don't think
it's as fabulous as people here seem to have convinced themselves it is.

On the other hand, Brewer is a lot smarter than me, at least where bonds are
concerned, and I'd love to be told why I'm wrong !




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Re: Seems ISM is taking a bit of a beating this week...
Old 02-24-2007, 08:46 PM   #24
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Re: Seems ISM is taking a bit of a beating this week...

Quote:
Originally Posted by RustyShackleford
And ISM is kinda looking at the derivative of inflation, not
the integral. If inflation spikes one year and then becomes low, ISM pays great
dividends during that year, and then not so good; whereas TIPS pays based on
the inflated principal from then on.
I won't try to tell you why you are wrong, or even that you are wrong, but if one is trying to use ISM to mimic TIPS, then the inflation adjustments should be re-invested into more shares as one goes along. This would be similar to what is done with a TIPS fund.

Ha
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Re: Seems ISM is taking a bit of a beating this week...
Old 02-24-2007, 09:00 PM   #25
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Re: Seems ISM is taking a bit of a beating this week...

Quote:
Originally Posted by RustyShackleford
Not quite. For one thing, the returned principal is exactly $25, regardless
of inflation; so dependng on whether inflation over the next 11 years is
greater/less than 1.6% annually, the principal will under-/out-pace inflation
(since the 11th-root of 25/21 = 1.016). TIPS exactly matches inflation.

For another, the coupon is only 2.05%, not 2.375%. And it's added to inflation
over the last year. TIPS is added to the cumulative inflation since you bought the
thing. So ISM is probably doing better until the cumulative inflation hits 25/21,
and worse afterwards. And ISM is kinda looking at the derivative of inflation, not
the integral.
Who said I'd never use calculus after you leave college LOL.

Thanks for clearing this up Rusty. However, my brain is starting to hurt.
Does the smart bond folks think this is a better alternative to a 2.375% 10 year TIP or worse? My 3.875% TIPs bonds muture in Jan of 2009, I am interested in an alternative.


Quote:
On the other hand, Brewer is a lot smarter than me, at least where bonds are
concerned, and I'd love to be told why I'm wrong !
Clearly, I am why down in the pecking order of bond understanding.
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Re: Seems ISM is taking a bit of a beating this week...
Old 02-24-2007, 09:26 PM   #26
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Re: Seems ISM is taking a bit of a beating this week...

Quote:
Originally Posted by clifp
Who said I'd never use calculus after you leave college LOL.

Thanks for clearing this up Rusty. However, my brain is starting to hurt.
Does the smart bond folks think this is a better alternative to a 2.375% 10 year TIP or worse? My 3.875% TIPs bonds muture in Jan of 2009, I am interested in an alternative.


Clearly, I am why down in the pecking order of bond understanding.
Best thing is to understand it or pass.

Ha
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Re: Seems ISM is taking a bit of a beating this week...
Old 02-24-2007, 09:41 PM   #27
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Re: Seems ISM is taking a bit of a beating this week...

The laymans (non heavy math) version...

You're getting the bonds at a nice discount, you'll most likely get that four bucks or so extra per share when they mature, unless of course SLM goes belly up. Probably not gonna happen.

Since you're buying them at a discount, you're also getting a discount on the CPI and the 2.05% coopun, so they're 'fatter' by that same margin.

Tips doesnt pay out the inflation adjustment, just the coupon. But you pay taxes on the inflation adjustment every year.

ISM pays out the inflation adjustment, so the future payouts arent inflation adjusted on the basis of principal unless you reinvest the inflation portion into more ISM.

ISM might return to closer to its face value well before it matures, so there may be an opportunity for a nice little capital gain for those not holding to maturity.
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Re: Seems ISM is taking a bit of a beating this week...
Old 02-24-2007, 09:52 PM   #28
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Re: Seems ISM is taking a bit of a beating this week...

The inflation-adjusted principal of TIPS seems to confuse a lot of people. I'm not sure why. It's just reinvested interest.

You might ask yourself why the treasury decided to adjust the principal rather than pay out the CPI component of interest. The answer is "deflation."

If you were the treasury, how would you handle the case of deflation?

If deflation was -3% and the real coupon was 2%, what would you do? Ask for money back? The treasury doesn't need to ask for money back, they simply take it out of the adjusted principal.

In this way, ISM is better than TIPS. ISM will pay 0% in the case above, whereas TIPS will actually have a negative return. Not a huge deal, really, but there is no good argument that TIPS are "better" than ISM wrt to adjusted principal vs CPI payout.
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Re: Seems ISM is taking a bit of a beating this week...
Old 02-24-2007, 11:37 PM   #29
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Re: Seems ISM is taking a bit of a beating this week...

Well I sat down and created a spreadsheet to compare ISM vs TIPs. ISM is better, assuming you can live with the risk that Congress decide to get out of the business of guarrantee Student Loans which would impact Sallie Mae. Assuming a reinvestment of dividends for both ISM and a mythical 11 Year TIPs bond @2.375%. (Which obviously isn't practically because of the monthly dividends from ISM)
It looks like ISM provides a future value that is almost 200 basis points higher than the same TIPs at the current price of $21.32

The major assumption I made was that ISM approached par at either a linear rate or an exponential rate of 1.3% per year. Varying interest rates didn't seem to matter much.


Now you all got promise you aren't going to get early the morning before us Hawaii boys have time to buy some of these puppies.

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Re: Seems ISM is taking a bit of a beating this week...
Old 02-25-2007, 01:26 AM   #30
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Re: Seems ISM is taking a bit of a beating this week...

Quote:
Originally Posted by clifp
Now you all got promise you aren't going to get early the morning before us Hawaii boys have time to buy some of these puppies.
We'll be the ones selling to you. Why do you think we've been pumping ISM?
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Re: Seems ISM is taking a bit of a beating this week...
Old 02-25-2007, 09:05 AM   #31
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Re: Seems ISM is taking a bit of a beating this week...

Funny, but that thought occurred to me briefly yesterday while we were on our brief tour of 17 prospective new homes :P

"Gee, I wonder if this is just one of those schemes where a couple of guys pump a thinly traded issue on a web site populated by high net worth individuals to create some arbitrage volatility...?"
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Re: Seems ISM is taking a bit of a beating this week...
Old 02-25-2007, 09:24 AM   #32
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Re: Seems ISM is taking a bit of a beating this week...

Lest we all get overexcited by ISM, there are two very similar securities: OSM, which is the same issuer, 5BP lower coupon, 1 year sooner maturity and trading at about the same YTM; and PFK, which is issued by Prudential Financial (rated one notch lower than SLM), matures in 2018, and trades at 50BP lower YTM.
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Re: Seems ISM is taking a bit of a beating this week...
Old 02-25-2007, 10:43 AM   #33
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Re: Seems ISM is taking a bit of a beating this week...

Brewer,

Since you've had ISM for awhile, can you tell me if the "dividend" paid on ISM is treated as a qualified dividend for tax purposes or an ordinary dividend, or even as interest. Suspect it is non-qualified but thought I'd ask. If it was qualified, that would amount to a potentially significant tax break.

Thanks,

RE2Boys
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Re: Seems ISM is taking a bit of a beating this week...
Old 02-25-2007, 11:24 AM   #34
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Re: Seems ISM is taking a bit of a beating this week...

Quote:
Originally Posted by RE2Boys
.............. can you tell me if the "dividend" paid on ISM is treated as a qualified dividend for tax purposes or an ordinary dividend, or even as interest. Suspect it is non-qualified but thought I'd ask. If it was qualified, that would amount to a potentially significant tax break.
ISM is a note (bond) which trades on the NYSE. The "dividend" is an interest payment and is taxed as ordinary income.
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Re: Seems ISM is taking a bit of a beating this week...
Old 02-25-2007, 11:27 AM   #35
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Re: Seems ISM is taking a bit of a beating this week...

Quote:
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ISM is a note (bond) which trades on the NYSE. The "dividend" is an interest payment and is taxed as ordinary income.
I'd go a step further and suggest that it is an ideal investment for an IRA.
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Re: Seems ISM is taking a bit of a beating this week...
Old 02-25-2007, 01:42 PM   #36
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Re: Seems ISM is taking a bit of a beating this week...

Quote:
Originally Posted by clifp
Well I sat down and created a spreadsheet to compare ISM vs TIPs. ISM is better ...
I concur, attach my similar spreadsheet, apologize for my spurious arguments
that ISM *may* not be as good as TIPS under certain conditions, and bow to
Brewer.

Mine also assumes a putative 11-yr TIPS that matures in Jan 2018 with the ISM
bonds, and makes the somewhat TIPS-favoring assumption that price is 99.
(The 10-yr TIPS that was auctioned last month was priced at 99.34).
I assume both would be in an IRA so tax can be ignored. Since ISM has no
DRIP-ability (at least not with Chuck), I simply assume that the interest from
both TIPS and ISM are deposited into a money-market fund which earns an
interest-rate equal to the annualized inflation (over the 11 years) plus 1%.
At the beginning of 2018, I take the m'mkt account, combine it with the
maturing bonds, and see what the total is. Then compute the average annual
return for each, and the real return. In every combination of inflation I try
(flat 0%, flat 3%, flat 10%, big bubble early as shown here, big bubble late)
the ISM has a real yield about 1% higher than the real yield of TIPS.

I wish there were a way to attach the XLS file, because I'd love someone to
check my work - because I find this really exciting - a guaranteed (subject to
the viability of Sallie Mae) real yield of 3.5 % ! (That supports an SWR of 4.4%
for 40 years).

Now excuse me while I go check the pressure on the truck tires !

P.S. Speaking of good Brewer ideas, I added some DSX to "juice up my
yield" and it's doing well. Anybody profit-taking yet ?






Attached Files
File Type: pdf TIPS_vs_ISM.pdf (11.6 KB, 10 views)
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Re: Seems ISM is taking a bit of a beating this week...
Old 02-25-2007, 02:17 PM   #37
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Re: Seems ISM is taking a bit of a beating this week...

Let's do a little ninth-grade algebra. To keep the math simple, assume interest is paid once per year, and the price of ISM is always 25.

R = annual coupon rate (e.g. the 2.05%)

I = annual inflation rate

N = years until maturity

Buy 1 share of ISM

Interest in year 1 = 25(R + I) = 25R + 25I

Reinvest the inflation component, 25I, in more ISM

Maturity value of ISM owned = 25 + 25I = 25(1 + I) => now own (1 + I ) shares

Interest in year 2 = 25(1 + I)(R + I) = 25(1 + I)R + 25(1 + I)I

Reinvest the inflation component, 25(1 + I)I

Maturity value of ISM owned = 25(1 + I) + 25(1+ I)I = 25(1 + I)(1 + I) = 25(1 + I)^2 => now own (1 + I )^2 shares

Also note that the real component of the interest, 25(1 + I)R, has grown at the inflation rate in year 2 (just like TIPS)

At maturity (after N years), the amount of ISM owned = 25(1 + I)^N. You will own (1 + I)^N shares of ISM with a par value of 25. Your principal (25 x number of shares) has grown at the compounded inflation rate (just like TIPS)

Clearly, this result can be generalized to the case where the inflation rate varies each year - just put subscripts on the inflation rate(s) - the results will be the same.

In the real world, the price of ISM will move around. This can lead to some slippage (or gain) relative to TIPS of the same initial real coupon rate. So long as the inflation component is reinvested at a price of 25 or less, the shares you own will grow at least as fast as the rate of inflation. However, to realize exactly the expected real yield-to-maturity (YTM), the reinvestments (as with any bond) must be at prices which have the same real YTM. So, there is some uncertainty as to what the actual achieved real rate of return of ISM relative to TIPS will be if held to maturity, due to this reinvestment effect. This reinvestment effect, as your spreadsheet indicates is relatively small, especially since you are purchasing the ISM at a substantial discount to par.
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Re: Seems ISM is taking a bit of a beating this week...
Old 02-25-2007, 02:35 PM   #38
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Re: Seems ISM is taking a bit of a beating this week...

Quote:
Originally Posted by RustyShackleford
P.S. Speaking of good Brewer ideas, I added some DSX to "juice up my
yield" and it's doing well. Anybody profit-taking yet ?
I let a quarter of mine go at 20, but only because I doubled my stake when it dipped under 16 recently. I am hanging onto the rest, although I am starting to have a serious concentration in that industry. What I decide depends on shipping rates. Usually they go down during the week of the Chinese New Year (last week). This year they went straight up. If rates keep popping this week as the Chinese (and the rest of Asia) are back at their desks, I plan on hanging on for a wild ride.
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Re: Seems ISM is taking a bit of a beating this week...
Old 02-25-2007, 03:28 PM   #39
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Re: Seems ISM is taking a bit of a beating this week...

Quote:
Originally Posted by RustyShackleford
Since ISM has no
DRIP-ability (at least not with Chuck), I simply assume that the interest from
both TIPS and ISM are deposited into a money-market fund which earns an
interest-rate equal to the annualized inflation (over the 11 years) plus 1%.
Rusty.... Nice analysis, thanks for the effort.

One question. Since the inflation component of the tips interest would be added to principal and compound at 2.375% + inflation, why add it to a money market and assume 1% + inflation? Minor detail, but..........

I've done some analysis myself and have tried to understand the work the rest of you have done. I think the reinvestment of the ISM inflation component is a key variable which is hard to model. And the higher inflation is, the more significant this becomes.

For myself, for situations where I want to park some money in a secure investment and know with certainty it will maintain/grow its value vs. inflation and be available having grown in real terms sometime in the future, I am chosing TIPS. For situations where I plan to spend or reinvest the interest payments in other opportunities, I chose ISM/OSM.

I have a significant position in ISM and am generally happy with it so far. But I realize that the inflation protection feature is heavily dependent on how reinvestment of the monthly payout goes. For the amount I own, one option would be to accumulate the payouts for three months which would approximately support the purchase of 100 additional shares.

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Re: Seems ISM is taking a bit of a beating this week...
Old 02-25-2007, 03:59 PM   #40
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Re: Seems ISM is taking a bit of a beating this week...

I think of it a bit more from the mechanics of my needs rather than the mechanics of the investment. I wouldnt own TIPS because I'm not fond of the idea of paying the taxes on the inflation adjustment and not getting it. My interest for this chunk of my portfolio is an inflation boosted income stream that only costs me tax-wise for whats being distributed to me. The lack of compounding without reinvestment sucks a little.

Anyone remember the Countrywide (I think) inflation indexed bonds that Charlie was touting a couple of years ago? I dont remember if they adjusted principal or paid out the inflation adjustment or what the rates were like.
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