#####################################################################Corporate Bonds#####################################################################What Are Corporate Bonds?• When companies need more capital than is available to them through ongoing cash flow, they raise it either through selling new shares of stock in the company or by borrowing (or, sometimes a combination).• Debt financing, usually with big investment banks acting as middlemen and taking a hefty cut, is in the form of corporate bonds.• Most corporate bonds are available to the general public only through the secondary market. ---It is now possible to buy some newly issued corporate bonds directly. Vanguard, for example, has commission free new issues for its Voyageur clients.• As with Treasuries, corporate bonds are issued with various maturity dates and with a fixed coupon rate.• Typically, bonds with longer maturities and/or lower qualities at time of issue have higher coupons. ---Some corporate maturities stretch out to 50 years or more.Why Would I Want to Invest in Corporate Bonds?Corporate bonds have higher yields than Treasuries of similar maturities.The higher yields are compensation for higher risk—even the highest rated companies have some risk of default in the future—with bonds from riskier companies paying higher yields.If you buy a corporate bond for a good price, you have the opportunity to sell it for a capital gain. ---A good price may simply mean you bought when interest rates were higher (as with Treasuries). ---You may also have bought for a good price, because the rating of the company's bonds has improved or, at least, the perception of traders is that the company's default risk is less. ---Out-guessing or out-foxing the market is how serious bond traders try to make big money.With many more corporate bonds than Treasuries, having a wide range of maturity dates, it is easier to find bonds that mature when you expect to need the cash.How and Why Are Corporate Bonds Rated?• Corporate bonds are rated for quality by independent institutions, most prominently S&P, Moody's, and Fitch.• These ratings affect how much interest a company will have to pay to attract buyers at the time of issue and for how much existing bonds can later be bought or sold.• The lower the quality, the more interest a company has to pay to borrow, because the company is considered to be at greater risk of default (failing to pay back the loan). ---The U.S. Government is treated as having essentially no default risk.• When a rating agency downgrades or upgrades the quality of a company's bonds, it does not change the coupon rate on an existing bond, so if you hold until maturity, you will continue to get the same payment, unless the company defaults.• An actual or anticipated change in rating does affect the sales value of a bond, since buyers assess the changed risk of default against the actual coupon rate (a downgrade means buyers will be willing to pay you less for the same bond). ---Traders reassess the default risk of bonds and build that into price on a daily basis, even without input from the rating agencies.• Investment grade bonds are rated (with slightly different nomenclatures) from AAA to BBB, using S&P nomenclature. ---Moody's uses Aaa for AAA, Baa for BBB, etc.• A rating of BB or below is considered a “high-yield,” or more colloquially, a “junk” bond.• A downgrade from the lowest “investment-grade” to “junk” does not mean there is really a great leap in the likelihood of default. ---However, because some bond funds cannot legally hold “junk” bonds, the affect of a downgrade on sales value, especially in the short term, exacerbated by momentum traders, can be dramatic.• Ratings are listed when you look at bonds being sold via your brokerage. ---They can also be found through various publications, such as Barron's.• For no log-on quotes for Corporate Bonds, see NASD: http://www.nasdbondinfo.com/asp/bond_search.asp ---Also, snap shot: http://apps.nasd.com/regulatory_systems/traceaggregates/nasd/default.aspxWhere Do I Buy Corporate Bonds?• Corporate bonds can be bought via bond desks or on-line through brokerages, typically for a slightly higher commission than for Treasuries, although there are now many discount brokerages that offer the same rate on all or most bonds. --- Vanguard's commission on corporate bonds is $25 plus $2 per $1000 bond.• Bonds are not sold through big, central, markets, like stocks, so you need to rely on the inventory available at your broker. ---Some people who would never use a full-service broker for stocks prefer one for bonds, because of larger inventories. ---Others use multiple brokerage accounts, in order to have a larger combined inventory and to choose whoever has the best deal for the same bond.• Beware of mark-up costs (the difference between the price listed for a bond and what you actually pay for it), which vary considerably between brokerages and might more than make up for differences between commissions.How Do I Figure Out What I Will Pay for a Bond?• What you will pay is: ---Price (after mark-up) multiplied by the face value (typically $1000) times the number of bonds; ---Commission; ---Interest accrued since the last coupon payment.• If yield-to-maturity is listed without commission, you will need to recalculate it. ---As a short cut, just divide the commission by the price times the number of bonds, then divide again by the years to maturity and subtract from the listed YTM. (For example, if you buy $20,000 of bonds with 10 years to maturity at par for a $65 commission, you subtract about 3 basis points from the YTM.)What Else Do I Need to Know About in Deciding Whether to Buy a Corporate Bond?• When you buy a corporate bond, you are basically weighing whether the higher yield is worth the added default risk.• Bond funds mitigate default risk by holding a diverse portfolio of corporate bonds. ---For individuals, it requires quite a lot of money to build a diverse portfolio, and if you buy only a small number of corporate bonds, you won't have much diversification to spread out the risk. • If you are looking to buy a corporate bond as a fixed-income investment, with idea of holding to maturity (active traders have additional concerns), what you really want to know from a listing is: how long until the bond matures, its quality, call provisions, and its “yield-to-maturity” (usually listed).• The YTM can then be compared with that of other corporate bonds or Treasuries bought for a premium or discount or with the annualized yield of a CD or a bond bought at or near par (e.g., new auction issue). ---Annualized yield is the compounded interest over the remaining life of a debt instrument, divided by the remaining time. Annualized yield can also be extrapolated by assuming the CD or bond will be rolled over into one with the same simple yield or coupon ---If the coupon on the bond is not too different (within 100 basis points or so) from prevailing yields, it is probably sufficient for decision making purposes to use the bond's “current yield” (coupon divided by price, including commission) or “adjusted current yield” (coupon divided by price plus or minus the difference between price and face value divided by time till maturity) for comparison with the simple yield of a CD or a bond bought at par. • The basic questions (from a buy-and-hold perspective) are: ---Is YTM is attractive enough to warrant the added risk compared to the other options? ---Is the YTM attractive enough to warrant locking in the yield for the length of time until maturity?• Inexperienced bond investors need to pay careful attention to the maturity date, not just the yield. ---A yield on a bond maturing in 25 years may look attractive compared to current yields on bonds maturing in 5 years, but might seem much less attractive when you realize you are locking in that yield for 25 years. ---Owning a bond with a longer maturity than you can handle in terms of your need to get the principal back is a big problem if you have to sell for a loss. • Inexperienced (and experienced) bond investors also need to understand that weighing default risk against YTM is not as simple as looking at bond ratings, at least for anything below high investment grade (AAA and AA). ---Investors need to go beyond the ratings and to learn how to evaluate the company's default risk for themselves.• Moody's has an analysis of historical default rates that may be helpful: http://22.214.171.124/search?q=cache:rXQ250X78EIJ:www.lesechos.fr/info/medias/200050753.pdf+Default+Rate,+Corporate+Bonds&hl=en&gl=us&ct=clnk&cd=3&client=safari• Another issue with corporate bonds is the “call date.” ---Most companies reserve the right to buy back the loan at a call date (or call dates) long before the maturity date, when they must pay back the loan. ---If interest rates drop, it is to the company's advantage to take out a new loan at the lower rate (like refinancing a mortgage when rates go down), as long as the costs of doing so don't exceed the benefits.• For a bondholder, the consequences of calls vary. ---If you bought the bond at par (i.e., for its face value), you will get back what you paid for the bond, but will then have to find a new investment in the lower interest rate environment. (Some calls pay back somewhat more or less than face value, so you need to check to be sure.) ---If you bought the bond at a discount (i.e., for less than its face value), you will get back the full face value (or promised % of face value), which means your yield to call will be higher than your yield to maturity (the difference between what your paid and the face value gets averaged in over a shorter period of time), but again, you will need to reinvest in a lower interest rate environment. ---If you bought at a premium, your loss will get averaged in over a shorter time, making your yield to call less than yield to maturity, possibly even resulting in a negative total return. ---Yield-to-Worst, the worst result if there are several call dates, is usually listed when you buy or research a bond.
For no log-on quotes for Corporate Bonds, see NASD: http://www.nasdbondinfo.com/asp/bond_search.asp---Also, snap shot: http://apps.nasd.com/regulatory_systems/traceaggregates/nasd......Loki, The first link is worthless, because its data --bond quotes-- is stale, like as much as a year old. The second link is dead. One possible free source for bond quotes is the sub-section of Yahoo Finance that deals with bonds. But that, too, is worthless, because of its limited capacities. The only practical way to get timely quotes on bond prices is through TRACE (which requires a long explanation) or through a brokerage account that has a "bond screener" and whose access to inventory (the underlying desks that actually buy or sell the bonds) is extensive.IMHO, the best of the "discount" brokers for a would-be bond investor with a small account would be E*Trade, Fidelity, or Zions Direct. Possibly, Schwab and Vanguard should be added to that list. But I currently do not have accounts with them and, therefore, can say neither "yea" or "nay". I know Chris uses the full-service broker, Merrill Lynch, though she's been complaining lately about their lack of data and inventory. Also, there are "bond boutiques" through whom a would-be investor can buy bonds. But I'd advise avoiding them unless one is very well-heeled and very lazy. In short, this section of the Bond FAQ needs to be re-written. Charlie
How Do I Figure Out What I Will Pay for a Bond?• What you will pay is:---Price (after mark-up) multiplied by the face value (typically $1000) times the number of bonds;---Commission;---Interest accrued since the last coupon payment.• If yield-to-maturity is listed without commission, you will need to recalculate it.---As a short cut, just divide the commission by the price times the number of bonds, then divide again by the years to maturity and subtract from the listed YTM. (For example, if you buy $20,000 of bonds with 10 years to maturity at par for a $65 commission, you subtract about 3 basis points from the YTM.)Loki,The previous is what is found in the FAQ. The following would be my suggested re-write.XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXHow Do I Figure Out What I Will Pay for a Corporate Bond?There is no “figuring” to be done. A broker (either on the phone, or through the intermediary of an OFFERING LIST (look this up, and learn to run BOND SCANS. Repeat. YOU NEED TO CROSS-CHECK THE QUOTE AGAINST OTHER SOURCES, including how the market is pricing debt generally) will quote you a price (typically stated as a percentage of par) that you can either accept or reject. To that price there will probably be added a commission. These days, commish (the “vig”) is typically $1/bond with a minimum of $5-10 bucks. If you’re paying more, then you should be able to explain to yourself why. Additionally, as part of the total money exchanged in the transaction, you will have to buy whatever ACCRUED INTEREST (look this up) there comes with the bond, which is no biggie. Just be sure to recoup this when you file your taxes. (See your tax preparer, which might be yourself, for an explanation.)The price quoted to you will typically be the ASK (look this up), not the BID (ditto), nor will you be able to haggle in an attempt to SPLIT THE SPREAD (look this up). In other words, unless you know you are a big investor, i.e., someone who can buy IN SIZE (look this up), you have no bargaining power. The price quoted to you is what you will accept or reject. Additionally, the price might include a hidden MARK UP (look this up) from the INSIDE MARKET (look this up). (Alternatively, if you’re trying to sell, the offer made to you might include a MARK DOWN.)You need to be aware that bond prices, like stock prices, change frequently through the hours that the bond market is open. Depending on factors such as the LIQUIDITY (look this up) of the issue, the NEWS currently coming into the market, whether an UNDERLYING DESK (look this up) is dumping, etc., prices will change rapidly. A history of those price changes is inaccessible to the small, bond investor. However, TIME & SALES is available through TRACE. (look this up, and learn to use TRACE. Repeat: TRACE IS AN IMPORTANT PRICE-DISCOVERY TOOL.)Lastly, never trust a broker’s reported YIELD TO MATURITY (look this up). ALWAYS RUN YOUR OWN NUMBERS. There are no exceptions. ALWAYS RUN YOUR OWN NUMBERS. The reason is simple. What you thought was a good deal might not be so once total cost and benefits are calculated. OTOH, what you thought was a good deal might actually be an even better one (because of inherent faults in how brokers calculate YTM). You won't know which is which until you've run your numbers. The math is simple. Learn to calculate your own YTMs on the fly. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX (rev. 03/28/09)
Loki, With this portion of the FAQ on corps, I’ve simply inserted my comments in bold face. Obviously, in any “final version”, the bolding should be removed.XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX How and Why Are Corporate Bonds Rated?• Corporate bonds are rated for quality (alternatively, the issuing-company is rated for “credit-worthiness”, by supposedly independent institutions, most prominently S&P, Moody's, and Fitch, whose impartiality, accuracy, and timeliness can never be entirely trusted. A “rating-house” rating is merely a rough guideline that has to be vetted by the investor’s own credit-analysis of the company and then double-checked against how the bond market itself, though pricing, is assigning an implied credit-rating. • Ratings affect the coupon that a company attachs to a bond to attract buyers at the time of its issue. Ratings, as they are subsequently revised up or down, are an important factor in how those bonds will be subsequently priced in the secondary market. Thus, ratings matter, and companies who choose to raise capital (whether by issuing debt or equity) are very concerned with their ratings, even to the extent of misrepresenting their financial facts in order to access credit cheaper than if their true circumstances were known. • The lower the credit-wortiness of the company, the more a company has to pay to borrow money, because the company is considered to be less able to repay its debts. Typically, the “pay more” factor is reflected in the coupon attached to the bond. Top-tier debt typically has coupons that never exceed 7%. Lower-quality companies typically offer coupons as high at 12%. Such bonds are “new-issue high-yields”, a fairly recently developed asset class. • When a rating-agency revises its estimate of a company’s credit-worthiness, the coupon on an existing bond typically does not change, because it typically cannot be changed, due to the bond’s convenants. (There are exceptions to this, and they will be spelled out in the convenants.) Thus, if you hold until maturity, most likely you will continue to receive the same coupon payment unless, of course, the company defaults. :-/• Anticipated rating-changes, as well as actual ones, affect the price of a company’s bonds in the secondary market. An upgrade implies that the risk of credit-impairment has lessened, just as the opposite is true. Investors pay more for safety; they pay less for increased risk. As price increases, yield decreases, and the opposite is true. Thus, the yield from a bond is a function of its coupon rate, its rating-house rating, and its market-implied rating, prevailing interest-rates, and general market conditions. ---Would-be bond-buyers and current note-holders can (re-)assess the default-risk of a bond by how it is being priced in the secondary market, which is a more accurate and timely measure of changing credit-worthiness than the ratings of the ratings-agencies. This is due to how those who pay to have their debt rated choose to have the rating-houses respond to changing circumstances. They do NOT want instant feedback on what are hoped to be minor financial fluctuations. Instead, the purchasers of ratings want slow, incremental “report-cards”. In fact, unless the company is sure to be upgraded, they hope the rating houses never review them.A quick explanation of the symbols used by the various rating agencies is found at Wikipedia. http://en.wikipedia.org/wiki/Bond_credit_rating• Speculative-grade debt, i.e., bonds rated BB or lower, are colloquially called “junk”. This can be meant as a disparaging term, or as an affectionate one, depending on the intentions of the user. • Possibly, a downgrade from “investment-grade” to “speculative-grade” might not mean that the likelihood of default the increased substantially. However, bottom-tier, investment-grade debt is, for all practical purposes, “junk” that everyone already knows is junk but which the rating houses have been under pressure not down-grade further. This is due to the fact that most “institutionals” (who are the chief buyers of bonds) are typically prohibited (by charter, fiduciary rules, prospectuses, etc.) from buying spec-grade debt. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXAs you can see, not much of the original version survives as I would tell the tale. But, then, mine is only a single voice, and not the most experienced, either.
As a user of Chuck I would say that I am rarely overwhelmed by my choices and their screener behaves oddly sometimes. If you already have a Chuck account its a reasonable means of purchasing most bonds. If you want a broader selection it may be best to open an account elsewhere. If your current account doesn't have much in the way of bonds and you are planning on opening an account for that purpose I wouldn't recommend Chuck as a top choice.jack
Jack, Thanks for the feedback. Your report confirms my experiences with Schwab when I did have an account with them. They were good about mutual funds, expensive (but OK) for stocks, and inadequate for bonds. In part, I suspect that the explanation lies with Chuck himself who hates bonds. Thus, although the company realizes that bonds are important to their clients, they don't make much of an effort to service that need, because that isn't a burning interest of their leader, who, by all accounts, really is a decent guy whom the troops all love. But bonds aren't his thing. So bonds take back seat as a company focus. That said, years ago I had the luck and privilege of wrangling an interview with their southwest regional manager for fixed-income. He knew junk bonds. He loved junk bonds. It was fun talking with him. Charlie
Charlie,I need to take a run at Chucks financial statements and their public statements. I'm not convinced that Chuck hates bonds, I think Chuck hates the big stock and bond houses. Under current circumstances if Chuck could leverage the funds they may be a far more willing and a much larger player in the Bond game. That move would pique an interest for me to consider taking an equity stake. jack
I'm not convinced that Chuck hates bonds, I think Chuck hates the big stock and bond houses. No, no no. Chuck hates bonds. Read his books. For him, equities are what an investor should own. Period. He despises bonds with all the passion that Lynch did. That said, forget about that quirk of his and focus instead on Chuck as a person who cares deeply, passionately, and shrewdly about his company and the people who work for him. How is the company responding to the current business downturn? The bet has to be that, not only will they survive, but that they will kick serious butt in terms of their competitors. During the 2000-2003 downturn, they did four rounds of internal cutbacks and were gathering assets faster than their competitors. The bet has to be that they are currently doing the same this time, that they what doing what they should, rather than merely what they have to. Chuck, like Warren, like other people who care about their companies and their people, intends to take care of them and, as a consequence, shareholders. But not the other way around like most companies. Thus, the key factor in the analysis equation is the quality of management, not just the financials. Definitely, you should take an equity stake. That's a recommendation that's easy to make with a clear conscience. How much of a stake and when to do the nibbling are other matters. But digging into Schwab the company will pay off handsomely. "I guarantee it."
Charlie,Have you been re-reading Fisher? hee heeDefinitely, you should take an equity stake.Crap, guess I have some reading and crunching to do. Don't want my dry-powder to get wet.No, no no. Chuck hates bonds. . . .I may have to make a run to the library. I do know that he is shrewd, I also know the bond houses are deep into ugly. Will that create some kind of marriage? dunno.The bond houses being deep into ugly is a really interesting issue to me right now. Who gets stable first, and who get stable best are really good places to look for nice gains. jack
Have you been re-reading Fisher? hee heeFisher? I never heard of him, or, more accurately, I don't know who the Fisher is that you admire. But I've been re-reading Whitman and a guy called Jake Bernstein (a crap trader but one of the best on investing pyschology.)Also, I fail to understand your insistence on tying bonds to Schwab. First, you need to identify Schwab's typical client, who isn't E*Trade's (or AmeriTrade's) typical client in terms of typical account size, household net-worth, etc. Though Schwab is considered a "discounter", the firm really isn't. It mid-tier between the discounters and the full-service firms. That's its niche.The typical Schwab client owns some bonds, but he is buying what his account manager recommends. The account manager doesn't understand bonds. He's merely mouthing the morning sales briefing. In other words, he's passing on generic advice that won't come back to haunt them because it will likely achieve respectable relative performance. The "whales" do get personalized advice from guys like that manager I talked to. But he, too, knows that the whales are stupid about bonds and just want to be told what to buy. So everyone, from the lowest customer rep to the top man himself in the company , with rare rare exceptions, all do asset class shuffle and pay lip service to owning bonds but do so with no passion, no conviction, and no understanding. Thus, as a percentage of assets under management, or better, bond sales as a percentage of total security sales, I wouldn't expect to see Schwab's numbers depart from its peers. Thus, were I a stock investor, I'd own Schwab without a second thought. But as a bond investor, I'd never do business with them. As a bond investor, I'd use E*Trade. Were I a stock investor, I'd approach E*trade with a lot of caution.
Charlie,I fail to understand your insistence on tying bonds to SchwabI didn't mean to be insistent, at least in the way you perceived. Schwab is healthier than many of its peers, investment vehicles from more troubled peers are on sale. Do they act on that? is an interesting question. Who acts on that data is interesting. Who acts in a prudent way is a really interesting question. Every company is presented with opportunities. Passing on those opportunities may be their best choice; taking the risk and expanding "their typical client" base may be their best choice. Watching what they do is useful. The point is, if you don't at least try to project ideas ahead you'll never be waiting there when the slow heard money shows up. I don't know if I'm smart enough to get there early but I know fer-darn-sure that I won't be there if I don't think of scenarios that are possible, plausible or likely. I'm not hanging my hat on Schwab making a bond move. They have more potential then many of their peers. That's it, that's all. Right now Schwab's equity is mis-priced for my liking. They do what they do pretty well. The market recognizes this and prices accordingly. I like owning equity or debt in well run companies but not at what ever the current going rate is. jack
Jack,Ah, now I understand. You were thinking in terms of the acquisitions Schwab might make. I seriously doubt they are seeking to expand. In fact, I know from inside sources, they are hunkering down, hugely. Good people, with 25 years service --but who aren't multi-talented- are getting whacked. "Nothing personal; just business; and business isn't good."OTOH, Chuck is also taking care of those people: a year's severance pay, etc. Not "golden parachutes", but very generous easements into involuntary retirement. The internal rational is that the company has to survive and, according to my source, many very shrewd decisions are now being made to ensure that survival. As to how the stock prices out currently in terms of value, I haven't the slightest, since I don't buy stocks. If they issued bonds, though, I'd be pricing them and looking to acquire. Charlie
Charlie,First, thank you for your insight information from those within. Insights like these help investors get an idea who they are doing business with. It doesn't surprise me that they are not thinking about expanding via acquisitions. Schwab has tended to be focused toward their core which is most often a good thing for most companies. jack
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