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  1. #1
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    Default 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.

  2. #2
    Ignorant. Just ignorant.
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    Default You've more or less got it. . .

    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.

  3. #3
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    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 ...

  4. #4
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    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.

  5. #5
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    Quote Originally Posted by rabcat View Post
    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?
    Yes

    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?
    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.

    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?
    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.

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

    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.
    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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  6. #6
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    Quote Originally Posted by beacon View Post
    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 ..
    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
    Last edited by Snoopy; 28-11-2009 at 10:18 PM.
    Watch out for the most persistent and dangerous version of Covid-19: B.S.24/7

  7. #7
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    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.

  8. #8
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    Hi Rabcat,

    Quote Originally Posted by rabcat View Post

    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.
    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.

  9. #9
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    #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!
    Last edited by Enumerate; 03-12-2009 at 09:39 PM. Reason: Spelling
    Do not consider my postings as investment advice. I am here to share research and to speculate on what might be. The boundary between fact and conjecture might not always be clear - best to treat all comments as speculation.

  10. #10
    Member Alan3285's Avatar
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    Hi Enumerate,


    Quote Originally Posted by Enumerate View Post

    #4 Tip for bond buyers:

    Don't ignore the exotics ... leverage is not bad on the way up!
    What is an 'exotic'?

    Alan.

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