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Some questions on bonds
Old 11-04-2004, 05:16 AM   #1
 
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Some questions on bonds

I'm new to bond trading, so be gentle. I have some basic questions on bonds - they are sprinkled throughout.

How do I calculate the the value of a bond at maturity?

Assume a coupon of 2.75%, maturity date of 8/15/2007, price of 100.452 and a YTM of 2.579.

If I buy a $10000 bond with those valuse, how much will I have on 8/16/2007, not including taxes? It's a simple treasury. I know if it's a zero, it would be worth $10000. If I hold it to maturity, would it be better to buy a zero or a regular bond? (I know about having to pay taxes on the phantom interest on the zero)

There are several bonds that mature on that date - another one has a coupon of 6.125% but costs 109.452 and YTM of 2.562. I get higher interest, but pay more up front. Which is a better buy? Is there a reason why I would pay more up front to get essentially the same YTM?

I would plan on holding the bonds to maturity. In that case, YTM rules, right? If I wanted to bet on the bond market and assume that interest rates are going to rise over some time period, then the the price I could sell either bond for would fall. Which of the two bonds above would be the better bet? Or would it better to buy shorter term bonds while the rates are rising and then lock in the higher rates with longer term bonds?

Also, what happens when it matures, assuming that I have it held in street name at my brokerage? Does $10000 appear in my account?

Thanks for any help.
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Re: Some questions on bonds
Old 11-04-2004, 07:04 AM   #2
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Re: Some questions on bonds

Quote:
I'm new to bond trading, so be gentle. *I have some basic questions on bonds - they are sprinkled throughout.

How do I calculate the the value of a bond at maturity?

Assume a coupon of 2.75%, maturity date of 8/15/2007, price of 100.452 and a YTM of 2.579.

If I buy a $10000 bond with those valuse, how much will I have on 8/16/2007, not including taxes? It's a simple treasury. I know if it's a zero, it would be worth $10000. If I hold it to maturity, would it be better to buy a zero or a regular bond? (I know about having to pay taxes on the phantom interest on the zero)

There are several bonds that mature on that date - another one has a coupon of 6.125% but costs 109.452 and YTM of 2.562. *I get higher interest, but pay more up front. Which is a better buy? Is there a reason why I would pay more up front to get essentially the same YTM?

I would plan on holding the bonds to maturity. In that case, YTM rules, right? *If I wanted to bet on the bond market and assume that interest rates are going to rise over some time period, then the the price I could sell either bond for would fall. Which of the two bonds above would be the better bet? Or would it better to buy shorter term bonds while the rates are rising and then lock in the higher rates with longer term bonds?

Also, what happens when it matures, assuming that I have it held in street name at my brokerage? Does $10000 appear in my account?

Thanks for any help.

- At maturity, you get the face amount of the bond plus a coupon. Even if you buy a bond at 102, you get 100 at maturity.

- In your example 2007 bond, you would get $10,275 at maturity.

- A zero vs a coupon bond is up to you. Zeros can be handy for defeasing future cash needs that you know with certainty.

- You pay a lot more for the bond with the higher coupon to keep the YTM about the same. Some people will buy these types of bonds because they have slightly lower duration than a bond that matures on the same day, but has a lower coupon.

- If you are buying to hold, then look at YTM unless the bond is ccallable. I would avoid callable bonds if I were you, since retail investors usually get the shaft with callables. The two bonds you cite are probably about the same for a HTM investor, although the bond with the above-market premium will be a slightly bigger headache at tax time.

- On interest rate risk: you are looking at two bonds that both mature in two and a half years. Since they are pretty short duration, your interest rate risk is very low. Personally, I wouldn't bother buying treasuries as a retail investor. You get higher yields and roughly equivalent safety by buying CDs or putting money into something like INGDirect. You are talking about picking up .3% yield with treasuries over ING, but taking on some interest rate risk to do so. Not worth it, IMO. You could also find CDs of equivalent maturity with higher yields.
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Re: Some questions on bonds
Old 11-04-2004, 07:59 AM   #3
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Re: Some questions on bonds

[quote]
the bond with the above-market premium will be a slightly bigger headache at tax time.

brewer, I've been wondering about this for a while. I had some bonds mature, and since they were bought at a premium, I had a long term capital loss appear in my Fidelity account. When I downloaded the data to TurboTax, this flowed through automatically to offset capital gains, and also up to $3k of income that year.

All seemed pretty straightforward, and actually meant that the effective YTM was slightly higher, since there was a small tax advantage from the LT loss.

I'm assuming this is the correct procedure ... ?

Peter
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Re: Some questions on bonds
Old 11-04-2004, 08:16 AM   #4
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Re: Some questions on bonds

Dunno, since I generally don't buy individual bonds. I was under the impression that the taxpayer was supposed to amortize the premium or discount over time. Turbotax makes things much, much easier, so I would generally go with it.
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Re: Some questions on bonds
Old 11-04-2004, 08:24 AM   #5
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Re: Some questions on bonds

Amortization will usually save you some taxes. With taxable bonds, you have the option to amortize or not. With tax-exempt bonds, you don't have a choice -- you must amortize.
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Re: Some questions on bonds
Old 11-04-2004, 01:17 PM   #6
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Re: Some questions on bonds

A couple additional points on bonds:

YTM is the only thing that matters, with the exception that if it is a callable bond, you care about YTC - yield to call. *Dont even think about maturity on a callable bond, because you have to price it on the assumption that it will be called.

Big coupons on a bond (which you buy 'at a premium') is just a way of giving you back some of your capital along with an interest component every 6 months or whatever. *There is no more magic in it than that, (with the exception that it can reduce duration a bit, but I think that should be immaterial for us). So the low or high coupon bond will have its price adjusted so that every bond is an equally good deal -- the markets are efficient like that.

The much bigger bugaboo is this: *fees and spreads. *I think we individuals should not be buying 'used bonds' except perhaps treasuries from Treasury Direct. *The fees and spreads will kill any benefit of finessing the yield curve or credit risks and owning the perfect bond, based on everything i've seen in the retail bond market. *Really, its a huge clip joint and we are the suckers.

Buy new issues only, and hold them to maturity. *Thus, you don't really have to worry about any of the compariing of bonds based on coupon, YTC, YTC etc., since yield (coupon) and YTM will be (essentially) the same on a new issue, which should come out at par, or 100.

Vanguard BondDesk has/had a good calculator that I used before I swore off buying and selling used bonds.

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Re: Some questions on bonds
Old 11-05-2004, 06:13 AM   #7
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Re: Some questions on bonds

Yep, spreads are the main reason I don't buy individual bonds. Looking at the yields on bonds I am offered by Schwab makes it really clear that I would be taking on credit risk in return for less yield than I could get from a CD of equivalent maturity. No thanks, guys.

On callables: actually, the way to value a callable is to value the bond as if it were a bullet, then value the call. The straight bullet value minus the call value equals the value of the bond. It isn't easy to do the valuation of the call, and it is generally not worth the effort because callables offered to retail investors inevitably are a bad deal. Issuers of these bonds know that retail investors undervalue the call, so even if they don't care about the call prtovision, they issue callables and then sell off the call in the capital markets.
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Re: Some questions on bonds
Old 11-06-2004, 09:45 PM   #8
 
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Re: Some questions on bonds

[quote]

...

- In your example 2007 bond, you would get $10,275 at maturity.

I thought that the rate was a yearly rate paid twice a year. so I'd get 7 or so payments of $275/2 every six months?

...
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Re: Some questions on bonds
Old 11-07-2004, 08:30 AM   #9
 
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Re: Some questions on bonds

On a "normal" bond, which pays interest every six months, you would get half of the coupon every six months for the duration of the bond. So, for a $10,000 3 year bond with a 2.75% coupon, you would get a coupon payment of $137.50 every six months until the bond matures, and then your original $10,000 back as well.
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Re: Some questions on bonds
Old 11-08-2004, 06:55 AM   #10
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Re: Some questions on bonds

Quote:
...

- In your example 2007 bond, you would get $10,275 at maturity.

I thought that the rate was a yearly rate paid twice a year. so I'd get 7 or so payments of $275/2 every six months?

...
Yeah, I figured my response would cause problems. What you would get at maturity is the face amount ($10000) plus a coupon ($137.50 for a semi-annual pay bond).
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Re: Some questions on bonds
Old 11-09-2004, 09:35 PM   #11
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Re: Some questions on bonds

I was wondering about anyone's experience with junk-bonds... now not for the risk-adverse of course, but I just finished a book about michael milken and he makes sense when he states that traditional bonds offer very little upside but large risk. junk bonds would seem to behave very similar to equities with somewhat less risk... hmmmmmmm...
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Re: Some questions on bonds
Old 11-10-2004, 03:16 AM   #12
 
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Re: Some questions on bonds

I have only used junk indirectly as part of a High
Yield fund. However, if I were much younger, I would
make junk bonds a significant part of my portfolio. With me,
it's all about recovery time in the event of a meltdown.
I no longer have any.

John Galt
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Re: Some questions on bonds
Old 11-10-2004, 03:38 PM   #13
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Re: Some questions on bonds

Quote:
I was wondering about anyone's experience with junk-bonds... now not for the risk-adverse of course, but I just finished a book about michael milken and he makes sense when he states that traditional bonds offer very little upside but large risk. *junk bonds would seem to behave very similar to equities with somewhat less risk... hmmmmmmm...
There is money to be made in junk at times. However, you have to time it right if you are thinking about investing in a junk fund. A great time to invest was late 2002 to early 2003. Junk spreads blew out something like 1000 basis points over historical average, then tightened like crazy over the course of 2003. Anyone paying attention made lots of dough.

There is also lots of money to be made in single names, but you have to be pretty good at credit analysis. I know someone who does this sort of thing for a living, trading mostly in Ba/BB names that are going through a rough patch, andf there is plenty of nice dough to be made. But you gotta be sharp and work at it.
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Re: Some questions on bonds
Old 11-11-2004, 05:04 PM   #14
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Re: Some questions on bonds

Junk bonds are the bond equivalent of value investing. Will go in and out of season, but by and large a good idea imho if you can get it diversified at a reasonable cost.

Note that junk bonds will tend to move more with stocks than with bonds.

I have owned Vanguard High Yield Corporate for many years. They are the princes of junk -- taking only the higher quality junk (BBBs) and none of the Cs as I remember. Thus they will underperform the index in good times, but outperform it when junk gets whammed. I have been happy with that tradeoff.

ESRBob
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