Understanding Bond Trading.

Can some one please explain the fixed interest securuties for me.

If I look at the the market I understand the coupon rate ( the interest rate when the bonds were issued?)

And the maturity date is the date you get your money back?

But the buy and sell I am not sure about. I assume that say for Hellaby Holdings the buy of 12.9 means I would get 12.9% interest on the money I invest,while the sell 12 means 12% interest?

Also if the coupon rate is 8.5% and I buy at 12% then if i buy a $100 worth then I acually get $141 worth of bonds? Is that correct?
So if i hold those bonds to maturity Hellaby will pay me out $141? And also pay me $12 interest per annum?

Lastly what is the minimum number/ value I have to buy? Do you buy them like shares 1000 or 5000...? or do you buy them in $1000 or $5000.

I look forward to an answer thanks.

OK, broadly speaking, it works like this:

You buy a bond at $1 face value. Normally you buy in 5k or 10k multiples. Lets assume you buy $10k at issue

Your bond has a coupon rate of 8%, the issuer pays you $800 pa, and you get your face value back at maturity.

But hey - interest rates rise. And you need to sell. So 8% is no longer all that attractive, so nobody's gonna pay you $1. They'll pay you (say) 90c, so that they get a decent return. You take a capital loss.

They keep getting 8% on the $1 face value, but have paid only 90c in the dollar, so the effective interest rate is 8.9%. And there's an 11% capital gain at maturity.

Put those together, with some other stuff that I have difficulty understanding, and you get the yield.

They repay you face value at maturity if they haven't gone belly up by then. In the latter case, they pay nothing, then their paper is only useful for wiping windows or bums...

If the coupon was 8.5%, they pay you $8.5 pa rather than $12 pa in your example, regardless of the discount you got when buying. handle with care ...

The frustrating part of bonds is knowing the individual terms and conditions that apply. The yield quoted is "yield to maturity" - basically the IRR on cashflow until the maturity date. What it doesn't allow for is that the issuer may have the right to roll the bonds over for an additional period and that the terms on which the coupon are set will be found in the fine print of a 150 page document issued 5 years ago.

Overall, my experience of bonds is that they have been more difficult to understand and follow than the equivalent equities and for far less return (and the odds of recovering a capital loss seem lower, despite any theoretical backing). With shares, it is important to understand the financial state of the underlying business. With bonds, it is important to understand the financial state of the underlying business AND to understand the specific characteristics that apply to the bond - often only available if you can find the original prospectus.

Still, having a mandate for income in one family portfolio means I continue to attempt to learn about and profit from the bond market, though perhaps with less enthusiasm than for equities.

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Originally Posted by rabcat

Can some one please explain the fixed interest securuties for me.

If I look at the the market I understand the coupon rate ( the interest rate when the bonds were issued?)

And the maturity date is the date you get your money back?

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Yes

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But the buy and sell I am not sure about. I assume that say for Hellaby Holdings the buy of 12.9 means I would get 12.9% interest on the money I invest, while the sell 12 means 12% interest?

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The difference in the 'buy' and 'sell' quoted percentages represent the spread between those offering to buy the bonds and those willing to sell them. A 'buy' of 12.9% means that someone is offering to buy Hellaby bonds at a yield of 12.9% if there is someone else out there willing to sell to them at that yield. If YOU want to buy these bonds but the only bonds being offered are those at 12%, then the yield that you would get is 12%, not 12.9%.

This is a similar concept to the buy and sell quotes for shares.

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Also if the coupon rate is 8.5% and I buy at 12% then if I buy a $100 worth then I actually get $141 worth of bonds? Is that correct?

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No. If you buy $100 worth of bonds what you get is $100 worth of bonds. The $100 worth of bonds may have been issued at $141, but that is irrelevant. The market is only pricing those bonds at $100 worth because the market has calculated that the '$41 extra worth of bond value' (on paper) that you thought you were buying has already been lost.

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So if I hold those bonds to maturity Hellaby will pay me out $141? And also pay me $12 interest per annum?

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Yes Hellaby will pay you out $141 when the bonds mature, if Hellaby's bankers don't have a prior call on the funds that you thought Hellaby had locked safely away to pay you back. Rest assured that if a bank is owed money, they will be paid back first. Then you will be left in a scramble with the other unsecured creditors to grab your respective share of any Hellaby share capital that remains. That may mean you don't get all of your capital back. And if Hellaby were to go into receivership you may have to wait years to even get part of your original capital back.

Of course the market may have decided that $41 in extra value has been 'lost' because the capital repayment date is so far out in the future that commercial uncertainty requires a time value of money discount. So you may get your $141, even though by the time you get it, that $141 will only be worth $100 in today's terms.

To answer your second question, yes if you buy $100 worth of bonds at a 12% market yield, then you will get $12 interest per year. However your tax paid will not be deducted at source correctly because the face value of the bond means tax was only deducted as if the interest was paid at 8%. Also if you do end up getting the full $141- back on a bond that you bought for a capital value of $100 then you will have to pay income tax on that $41 windfall capital gain regardles of whether you are a trader or not (unlike shares). And if that bond matures in (say) four years, then you will have to apportion that expected gain over the four years leading up to the maturity of the bond in your tax return.

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Lastly what is the minimum number/ value I have to buy? Do you buy them like shares 1000 or 5000...? or do you buy them in $1000 or $5000.

I look forward to an answer thanks.

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In practical terms the minimum number of bonds you should buy is determined by sum of the brokerage that you will be charged when both buying and selling. If the brokerage is high enough you may find that the real net coupon rate you will receive is reduced to such an extent that the whole deal becomes not worth it. With government stock many years ago IIRC, I think I needed to buy $100k worth to get a really low broker commission charge. In the end I think I bought some $25k worth which I decided was OK because I planned to hold those bonds to maturity which 'back then', was many years into the future.

SNOOPY

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Originally Posted by beacon

If the coupon was 8.5%, they pay you $8.5 pa rather than $12 pa in your example, regardless of the discount you got when buying. handle with care ..

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Beacon, in the example quoted

"Also if the coupon rate is 8.5% and I buy at 12% then if i buy a $100 worth then I acually get $141 worth of bonds? Is that correct?
So if i hold those bonds to maturity Hellaby will pay me out $141? And also pay me $12 interest per annum?"

you are correct in that Hellaby pay $8.50 on $100 worth of bonds at face value. However because Rabcat bought these bonds at a discount, then as far as Rabcat is concerned his income *is* a real and tangible $12, not $8.50.

SNOOPY

Thanks for all the replies. It is good to know there are a few people who understand them. I have learnt a lot from your replies, enough in fact to keep me trading shares as they seems a little less complex and more flexible.

Hi Rabcat,

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Originally Posted by rabcat

Thanks for all the replies. It is good to know there are a few people who understand them. I have learnt a lot from your replies, enough in fact to keep me trading shares as they seems a little less complex and more flexible.

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I would most definitely agree that you should only trade things that you are comfortable with and which you understand.

The biggest issue for most people is time.

Its not whether you could or could not understand anything in particular (most of us can), but whether you have the *time* required to get there.


Having said that, I do believe that for many investors, a fixed interest component to their portfolio adds diversity and stability that a 100% equities portfolio might lack.

Fixed interest should be more 'staid' than the roller-coaster you get with equities (note: I did say *should*!) and as long as the borrower does not go bust, your return is generally fixed for the duration at the time of purchase if you hold to redemption (there are some exceptions of course).

Also, if a company does go bust, bond holders are more likely to get something back than equity holders, although how much more likely is another matter.


Good luck!

Alan.

#1 Tip for bond buyers:

If you want to know the dollar value per $100 face, of the bond you are interested in ...

Go to www.nzx.com and look up the symbol. They quote the interest rate buy and sell and the dollar per $100 face buy and sell.

There are a few wonderful bargains in bonds - due to the terrible liquidity. However, there are many more dogs ... do your research ...

#2 Tip for bond buyers:

I have said it before ... but www.companies.govt.nz is a wonderful site for fossicking the terms and conditions (Trust Deeds, Prospectii, etc.) of those bonds you are researching.

Always understand your degree of subordination and make sure you know your rights to force administration to recover your money. If you are deeply subordinated and have no rights to recover your money ... tread with caution.

#3 Tip for bond buyers:

A deep discount to face value is often, but not always, terminal. One man's road kill is another man's tenderised, sun kissed, highway jerky ...

#4 Tip for bond buyers:

Don't ignore the exotics ... leverage is not bad on the way up!

Hi Enumerate,

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Originally Posted by Enumerate

#4 Tip for bond buyers:

Don't ignore the exotics ... leverage is not bad on the way up!

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What is an 'exotic'?

Alan.

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Originally Posted by Alan3285

Also, if a company does go bust, bond holders are more likely to get something back than equity holders, although how much more likely is another matter.

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Bond holders will get money back after the banks have been paid back and after outstanding wages have been paid to workers out of a job.

The idea that bondholders will be paid out ahead of shareholders if things go pear shaped has long been touted as a reason for going into bonds if you as an investor are less tolerant for risk. However, as you hint Alan - in practice - I can't think of a single example in the history of the New Zealand market where shareholders lost everything and bondholders *did not* lose huge amounts of capital. Those same hapless bondholders then spent years getting drip fed only a fraction of the original capital they invested, while writing off all of the interest they thought they were due while waiting.

In New Zealand, unlike in the United States, we have lots of high yielding shares to invest in. Many of these pay annual dividends at a gross yield similar to the corporate bond rates. In fact some of these shares are the same companies that also market their own corporate bonds, the very same bonds we are talking about. The associated shares are of course volatile. But that volatility includes upside risk as well as downside risk. By contrast the drawdown downside potential on a bond (through company failure) is much higher than any capital upside risk. Indeed if you buy a bond in a new issue and hold until maturity, there is almost always no upside risk at all.

For this reason I no longer hold any company bonds in New Zealand listed companies or indeed finance companies. Instead I buy high yielding shares to fulfill the 'income' part of my investment portfolio. And if I want a genuine fixed interest product I am quite happy to put my money safely in a term deposit in the bank.

SNOOPY

Hi Snoopy,

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Originally Posted by Snoopy

Bond holders will get money back after the banks have been paid back and after outstanding wages have been paid to workers out of a job.

The idea that bondholders will be paid out ahead of shareholders if things go pear shaped has long been touted as a reason for going into bonds if you as an investor are less tolerant for risk. However, as you hint Alan - in practice - I can't think of a single example in the history of the New Zealand market where shareholders lost everything and bondholders *did not* lose huge amounts of capital. Those same hapless bondholders then spent years getting drip fed only a fraction of the original capital they invested, while writing off all of the interest they thought they were due while waiting.

In New Zealand, unlike in the United States, we have lots of high yielding shares to invest in. Many of these pay annual dividends at a gross yield similar to the corporate bond rates. In fact some of these shares are the same companies that also market their own corporate bonds, the very same bonds we are talking about. The associated shares are of course volatile. But that volatility includes upside risk as well as downside risk. By contrast the drawdown downside potential on a bond (through company failure) is much higher than any capital upside risk. Indeed if you buy a bond in a new issue and hold until maturity, there is almost always no upside risk at all.

For this reason I no longer hold any company bonds in New Zealand listed companies or indeed finance companies. Instead I buy high yielding shares to fulfill the 'income' part of my investment portfolio. And if I want a genuine fixed interest product I am quite happy to put my money safely in a term deposit in the bank.

SNOOPY

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Whilst I agree with pretty much all of that - it is after all, what I hinted at above above :) - the only thing I think bears emphasis is that volatility is a factor in BOTH capital value and income.

Whilst volatility and risk should be related, and as you say, higher volatility on share prices should lead to greater capital returns, the volatility of dividends / interest is also a factor.

For an investor that needs income to live on, they might be well advised to have a reasonable portion of their investments in bonds wherein the annual interest payments are likely to be very stable, whereas dividends, even on solid long term corporate performers, can be cut in difficult times.

One way to do that, if you don't want to hold corporate bonds, might be to invest in government (local or central) bonds where the risk of default is generally lower, and there are very few examples (at least in the developed world) of interest payments failing to be made.

If you do invest in overseas bonds, you will also introduce currency risk of course - unless you fully hedge which will often eliminate a subtantial portion of the returns unless you are already exposed elsewhere and purchasing the overseas bonds IS your hedge.

Having said that, I would be very cautious about investment in US or UK government bonds right now, due to the volume of money they have been creating recently. At the very least there must be a medium term inflation risk (and hence a downside currency risk) for those jurisdictions. Also, many commentators have pointed out recently that the US is already well outside the accepted norm for governement debt profiles - specifically the proportion of short term debt - to the extent that they are now regarded as an almost certain default (using the common analytical tools).

Now, clearly the US government, indebted in USD, cannot go bust if it doesn't want to ... it can just print more money to pay the bond holders off.

However, that just increases the probability of medium term inflation substantially reducing the value of the USD.


Anyway, now I am way OT since this is the NZDX forum, not the 'fixed interest' forum!

Alan.

just a quick point. the 'capital' gain/loss is taxable under the financial arrangement rules.

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Originally Posted by Alan3285

The only thing I think bears emphasis is that volatility is a factor in BOTH capital value and income.

Whilst volatility and risk should be related, and as you say, higher volatility on share prices should lead to greater capital returns, the volatility of dividends / interest is also a factor.

For an investor that needs income to live on, they might be well advised to have a reasonable portion of their investments in bonds wherein the annual interest payments are likely to be very stable, whereas dividends, even on solid long term corporate performers, can be cut in difficult times.

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Yes dividends *can* be cut in bad times Alan. But I have found that even in bad times directors are reluctant to cut dividends. Often they will keep paying dividends, even at a rate above current profits, to keep faith with shareholders in anticipation of better times. That means company dividend volatility is much less than company earnings volatility.

Dividend volatility can be further reduced by having a a spread of high dividend paying investments. Earnings do go up and down but generally not at the same time for all companies. You could for example buy shares in both a high yielding exporter and a high yielding importer. I never try to predict which way the dollar will move. But such a strategy means that one of your two companies will be helped whichever way the dollar moves!

I do like utility type companies too because generally their earnings volatility is much less than the market in general. Food companies, while not strictly utilities, do show similar characteristics because people need to eat and drink in both good and bad times.

The problem with a strategy like this is that if you suddenly need to call on your capital you might have to sell your shares when the market is down. For this reason I do run a fixed interest portfolio, which is materially smaller than my equities exposure, as well. This portfolio is made entirely of bank term deposits. I have six of these all of which are invested for a six month term, but with staggered maturity dates. That means that every month I know that one of my term deposits will be maturing. This way I preserve monthly access to cash , should something come up, while retaining the benefits of the higher interest rates available on medium term fixed interest investments. It all works for me, sans bonds. YMMV.

SNOOPY

Hi CJ,

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Originally Posted by CJ

just a quick point. the 'capital' gain/loss is taxable under the financial arrangement rules.

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Please can you elaborate.

Which capital gain / loss are you referring to?

Thanks,

Alan.

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Originally Posted by Snoopy

Yes dividends *can* be cut in bad times Alan. But I have found that even in bad times directors are reluctant to cut dividends. Often they will keep paying dividends, even at a rate above current profits, to keep faith with shareholders in anticipation of better times. That means company dividend volatility is much less than company earnings volatility.

Dividend volatility can be further reduced by having a a spread of high dividend paying investments. Earnings do go up and down but generally not at the same time for all companies. You could for example buy shares in both a high yielding exporter and a high yielding importer. I never try to predict which way the dollar will move. But such a strategy means that one of your two companies will be helped whichever way the dollar moves!

I do like utility type companies too because generally their earnings volatility is much less than the market in general. Food companies, while not strictly utilities, do show similar characteristics because people need to eat and drink in both good and bad times.

The problem with a strategy like this is that if you suddenly need to call on your capital you might have to sell your shares when the market is down. For this reason I do run a fixed interest portfolio, which is materially smaller than my equities exposure, as well. This portfolio is made entirely of bank term deposits. I have six of these all of which are invested for a six month term, but with staggered maturity dates. That means that every month I know that one of my term deposits will be maturing. This way I preserve monthly access to cash , should something come up, while retaining the benefits of the higher interest rates available on medium term fixed interest investments. It all works for me, sans bonds. YMMV.

SNOOPY

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Just a small word to say thanks helps for your input into this forum snoppy. Some time ago i was looking at putting a % of my investment into the DX as a regular income base but also I thought I was minimising my risks. I just couldnt get my head around yeilds, %'s etc. In the end I flagged it. Reading through this forum however tells me that I didnt miss much.

I do however have a much better understanding how dept bonds works after reading this forum.

Snoppy, you are really a quality poster and thanx heaps

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Originally Posted by Alan3285

What is an 'exotic'?
Alan.

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Things like the MCB010 - value is linked to the value of base and precious metal commodities

CEI - a "collar" around global dividend stocks with a bit of leverage thrown in.

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Originally Posted by dragonz

Just a small word to say thanks helps for your input into this forum snoopy. Some time ago i was looking at putting a % of my investment into the DX as a regular income base but also I thought I was minimising my risks. I just couldnt get my head around yields, %'s etc. In the end I flagged it. Reading through this forum however tells me that I didn't miss much.

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I think part of the problem is that many theories of investment equate risk with volatility. For most people it isn't a problem if their portfolio suddenly jumps up in value. In fact the risk that most investors should be concerned about is 'drawdown risk' ( the collapse of your capital base). And that is *not* the same as volatility.

I last put serious time into checking out the DX market back in the days when there were Brierley Investment's Bonds listed. At that stage I don't think the BIL ordinary shares were paying any dividends. But the bonds were looking quite attractive paying 13% or thereabouts on the secondary market. And that wasn't just one set of bonds. IIRC there were a whole series of BIL bonds/notes to the extent that you could pick the year you wanted your investment to mature and buy notes with that maturity date!

I tried to reconcile the price I would have to pay with the quoted yield and it didn't add up. Then I was told that although the bonds only paid their interest once (or twice?) per year, the price that I paid on the market would reflect that by discounting the value of the bond depending on how far away that interest payment was. My broker was helpful. But I have to say I don't think even he had a full appreciation of exactly how the price I was meant to pay tied in with those quoted market yields. In the end I think I gave up and bought some more Restaurant Brands ordinary shares instead. They were paying much the same yield at the time and the paperwork was easier! Of course up until earlier this year, with the benefit of hindsight, you might have said that this was a foolish decision...

Probably one decision that is still looking foolish is my decision to hold Telecom shares and not Telecom bonds. However, I never said to hold Telecom shares at the expense of all else. I said hold Telecom shares as part of a focussed share portfolio of around 10-12 shares. Put in that context the losses on my Telecom shares have been balanced out by gains in other income shares. So taking the portfolio view, my high yielding share 'income investment startegy' is still intact.

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I do however have a much better understanding how debt bonds works after reading this forum. Snoopy, you are really a quality poster and thanx heaps

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I just call things as I see them out of my own experience dragonz. I don't claim to be an Oracle. But if some of the stuff that I post is useful to you, and others, I guess that is good.

SNOOPY

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Originally Posted by Snoopy

I think part of the problem is that many theories of investment equate risk with volatility. For most people it isn't a problem if their portfolio suddenly jumps up in value. In fact the risk that most investors should be concerned about is 'drawdown risk' ( the collapse of your capital base). And that is *not* the same as volatility.

I last put serious time into checking out the DX market back in the days when there were Brierley Investment's Bonds listed. At that stage I don't think the BIL ordinary shares were paying any dividends. But the bonds were looking quite attractive paying 13% or thereabouts on the secondary market. And that wasn't just one set of bonds. IIRC there were a whole series of BIL bonds/notes to the extent that you could pick the year you wanted your investment to mature and buy notes with that maturity date!

I tried to reconcile the price I would have to pay with the quoted yield and it didn't add up. Then I was told that although the bonds only paid their interest once (or twice?) per year, the price that I paid on the market would reflect that by discounting the value of the bond depending on how far away that interest payment was. My broker was helpful. But I have to say I don't think even he had a full appreciation of exactly how the price I was meant to pay tied in with those quoted market yields. In the end I think I gave up and bought some more Restaurant Brands ordinary shares instead. They were paying much the same yield at the time and the paperwork was easier! Of course up until earlier this year, with the benefit of hindsight, you might have said that this was a foolish decision...

Probably one decision that is still looking foolish is my decision to hold Telecom shares and not Telecom bonds. However, I never said to hold Telecom shares at the expense of all else. I said hold Telecom shares as part of a focussed share portfolio of around 10-12 shares. Put in that context the losses on my Telecom shares have been balanced out by gains in other income shares. So taking the portfolio view, my high yielding share 'income investment startegy' is still intact.



I just call things as I see them out of my own experience dragonz. I don't claim to be an Oracle. But if some of the stuff that I post is useful to you, and others, I guess that is good.

SNOOPY

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Well at least you got the Restaurant Brands scenerio right as well. I remember you got some flax for this but it looks like this is on the up and up.:D

Hi Enumerate,

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Originally Posted by Enumerate

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Originally Posted by Alan

What is an 'exotic'?

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Things like the MCB010 - value is linked to the value of base and precious metal commodities

CEI - a "collar" around global dividend stocks with a bit of leverage thrown in.

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Yeah - that's definitely an 'interesting' one!

Thanks,

Alan.

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Originally Posted by Snoopy

I just call things as I see them out of my own experience dragonz. I don't claim to be an oracle. But if some of the stuff that I post is useful to you, and others, I guess that is good.

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I am reviving a old thread here. AFAIK it is still relevant in the detail being discussed in it. It is titled 'trading' but I think it is equally relevant for those investing in bonds.

People who buy a bond, have in IRD terms entered into something called a 'financial arrangement'. In tax terms, this means that any income derived must be declared on an accrual basis rather than a money received on the day basis. However, what I was not aware of before today is that if you meet certain thresholds, you can declare money you receive from bond investments on a cash basis. I don't think this is a new law. But the information put out by the IRD explaining it all looks very recent (consultation on this is still open up until the middle of April 2022).

Have a look here:

https://www.taxtechnical.ird.govt.nz...items/pub00396

SNOOPY

Further to Snoopy's post, there is an overview available from the IRD here