"Game Over" (for bonds) - Jonathan Clements

[dixter]

I believe my question was how the coupon affects your decision. And I will take your response to mean that you do not have an answer for me.

Ok.. lets make the answer easy to understand...

you buy a bond at par.. ($1000) you keep the bond till it matures and the issuer gives you back your $1000... so if there isn't any coupon payment during the duration of you holding the bond then the yld is ZERO YLD... you just got robbed by the issuer by using your money that you loaned him for FREE...

now, the next guy comes along and buys a bond from the same issuer... but this time the next guy has made a decision to loan the issuer the same $1000 and the issuer is going to pay a coupon every 6 months at the rate of 10%/yr...
so the guy holds the bond till it matures... he gets his $1000 back and he also got 10% per year coupon pay... thats a 10% YLD....

Now you see the value of the coupon rate.... that is a simple example...

but in practice what happens is the coupon rate is high in todays standard of investment grade bonds... so now the secondary market (bond traders) has determined that to get a 10% coupon you will need to pay a premium above the par value...
so its not un common to see a 10% coupon bond selling at 50% above par value... so that the bond now costs $1500 to hold, it still pays the 10% coupon during the duration but at the maturity date the issuer still only gives you par value ($1000) back, so the YLD is no longer 10% because you have to factor in the " Cost " of the high coupon rate... the Cost is the above par valuation given by the bond brokers..

Now you know...

 

[Out-to-Lunch]

but in practice what happens is the coupon rate is high in todays standard of investment grade bonds... so now the secondary market (bond traders) has determined that to get a 10% coupon you will need to pay a premium above the par value...
so its not un common to see a 10% coupon bond selling at 50% above par value... so that the bond now costs $1500 to hold, it still pays the 10% coupon during the duration but at the maturity date the issuer still only gives you par value ($1000) back, so the YLD is no longer 10% because you have to factor in the " Cost " of the high coupon rate... the Cost is the above par valuation given by the bond brokers..

Now you know...

I want to give you an honest, for-real thank you for typing up that explanation. There was nothing in it I was unaware of, but you didn't know that, sitting on the other side of the keyboard. So it was a decent gesture on your part to explain it to me as you did.

Let me not be argumentative: my original point/question was that on any bond I can purchase right now, I claim only the yield matters. (And, @O.S., I had typed in "YTM, YTW, etc." in my original question, but decided to delete it for the sake of simplicity.)

As you (@dixter) point out, the original coupon rate is part of the current yield calculation, but I don't see the relevance for my purchasing decision. Bonds with different coupons can have the same yield, as you said above. So I remain unclear on why your posts nearly always speak foremost about the coupon, as if it had importance for deciding whether to purchase a given bond or not.


Note: when I say "only yield matters," I mean ceteris paribus, i.e., same duration, call status, rating, convexity, taxability, etc.

 

[dixter]

One of the reasons I come onto early-retirement.org is to learn from others... If I get a question where I think it could help others I offer an answer... and if that answer is wrong I expect that I will get called out, and rightly so... and if I get called out and there is a possibility I could learn more at the same time.... there seems to be the " Investment Gods " that like to dictate to the less than informed... maybe those Gods are still in the business of selling investment products? I don't know... I got called out a couple weeks ago by claiming that yld to maturity doesn't matter... and the reason I still say that is because in todays low yld environment an investor looking for any descent ylds on bonds is going to end up paying above par.... and if you want/need to reduce the " cost " (above par valuations) of a higher yld bond then you most likely won't be holding the bond till maturity.... for example... if you buy a bond with 10% coupon and its valued at $1500 then it would be best to monitor the bond over time and attempt to recover the over par premium by simply reselling the bond before the maturity date... you may not get back the $500 cost in full but you could get close or if luck is on your side, even get back more than the $500... but you will never get the $500 cost back by sitting on the bond until maturity... so yld to maturity in that case is meaningless.. cause you don't know what yld you are going to end up with when you sell the bond back... you might get 9% or if really lucky you could get 12%..... just depends on how much you get via the coupons and the final value at the time you sell the bond back...

 

[dixter]

Sitting in my recliner with my coffee and my morning reading, two thoughts came to mind.

First, the admonition often attributed to Abraham Lincoln: "Better to remain silent and be thought a fool than to speak and to remove all doubt."

Second, my favorite internet cartoon: https://en.wikipedia.org/wiki/On_th...ows_you're_a_dog#/media/File:Internet_dog.jpg

Glad you spoke up... don't remember anyone calling you a fool or a dog...

 

[pb4uski]

I'll just take this post as a joke too...

any comments PB4... you teach this kind of stuff... explain how the coupon affects yld...

I agree with Out-To-Lunch... coupon rate is close to irrelevant.... all that I care about is effective yield, yield-to-call, yield-to-worst, etc.

You seem to have convinced yourself that coupon rate is relevant... I and many others have tried to explain to you why coupon rate is not so relevant but you don't seem to be getting it... so I give up... uncle.

 

[Out-to-Lunch]

for example... if you buy a bond with 10% coupon and its valued at $1500 then it would be best to monitor the bond over time and attempt to recover the over par premium by simply reselling the bond before the maturity date... you may not get back the $500 cost in full but you could get close or if luck is on your side, even get back more than the $500...

Forgive me if I am putting words in your mouth: Perhaps I could interpret these sentiments as asserting that the coupon rate (and concomitant inflated value over par) has an effect on the bond's convexity.... That is, that this bond would respond differently to changes in interest rates compared to other bonds of the same duration but different coupon (i.e., value vs. par).

Hmmm, I would have to think very hard about this, but I could perhaps believe it.

 

[dixter]

Forgive me if I am putting words in your mouth: Perhaps I could interpret these sentiments as asserting that the coupon rate (and concomitant inflated value over par) has an effect on the bond's convexity.... That is, that this bond would respond differently to changes in interest rates compared to other bonds of the same duration but different coupon (i.e., value vs. par).

Hmmm, I would have to think very hard about this, but I could perhaps believe it.

There are many different parameters that can affect a bonds value (either below par or above par).. coupon rates and durations are just two parameters... a bonds rating would be another parameter.. and many many more

I have no connection with Fidelity but here is a presentation that you might like...

https://www.fidelity.com/learning-c...come-bonds/corporate-bond-investing-recording

 

[NW-Bound]

... A big portion of my fixed income AA is in a Black Rock T-Fund. Its yield varies, and used to pay 2% which would offset inflation, but is now only 0.01%/yr!

I just looked at my wife's 401K Stable Value fund. YTD, it has paid 4.03% cumulative!

Wow, how do they do that? Loan sharking?

 

[Dtail]

I just looked at my wife's 401K Stable Value fund. YTD, it has paid 4.03% cumulative!

Wow, how do they do that? Loan sharking?

Could be heavy investing in riskier bonds such as mortgage backed bonds. This is true for my SV fund which has a current gross of 4.01%.

 

[NW-Bound]

Could be heavy investing in riskier bonds such as mortgage backed bonds. This is true for my SV fund which has a current gross of 4.01%.

Does not look too "stable" to me.

I don't know what my wife's fund does, but we have only 4.3% of investable assets in that fund.