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Author: opentolearn Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35392  
Subject: Understanding Mark Ups Date: 10/6/2002 12:45 PM
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I am trying to understand Bonds and find them very confusing. How do you know how much commission you pay, or is that not important? With stocks it's easy. Also do you recommend buying individual bonds from a discount broker such as E Trade or American Express, or go to a full scale brokerage like Merill Lynch which would have more of a selection. I was advised to go to the library and read Moodys to understand the tables so I could compare dates and yields, select a bond and specify the price I want to pay and then wait. I know I can buy Treasuries direct, but I'm really confused with the best way to buy other types of bonds.

Thank you for any information you can give me.
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Author: foobar73 Big red star, 1000 posts Feste Award Nominee! Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 4774 of 35392
Subject: Re: Understanding Mark Ups Date: 10/6/2002 1:29 PM
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I am trying to understand Bonds and find them very confusing. How do you know how much commission you pay, or is that not important? With stocks it's easy. Also do you recommend buying individual bonds from a discount broker such as E Trade or American Express, or go to a full scale brokerage like Merill Lynch which would have more of a selection. I was advised to go to the library and read Moodys to understand the tables so I could compare dates and yields, select a bond and specify the price I want to pay and then wait. I know I can buy Treasuries direct, but I'm really confused with the best way to buy other types of bonds.

Commissions are always important, unless for some reason you don't care when someone is taking money out of your pocket. Unfortunately, the way most bonds are sold, commissions are hidden in the price you pay, and usually not made explicit, as with stock trades. It's sort of like buying a car: the dealer takes a profit, but it's hard to figure out exactly what they're making, since their share is built into the price you pay. There are two things you can do to estimate the commission:

1) Get quotes from several different brokers. While this might not tell you the exact amount of the markup, it will at least let you know which brokers charge more and which brokers charge less.

2) Get quotes for both the buy and sell sides of the same transaction. If you figure the average of the buy price and the sell price for the same bond represents the "fair value" of that bond, then the difference between this fair value and the buy price represents the markup or commission you would pay to buy the bond.

It used to be difficult to get quotes for both buying and selling the same bond, as many brokers like to keep their commissions secret. One sometimes had to call the broker twice, hoping to get a different person on the phone, in order to get the other side of the transaction. Today, with online bond quotes and trading, you can often find both the bid and ask prices instantly.

Some brokers will charge an explicit commission, in addition to the hidden markup. When choosing a broker, you should keep this in mind.

Different brokers will indeed have different selections, and it might be worth it to keep several accounts with various brokers, in order to take advantage of this, if you are doing heavy trading. For casual use, I suspect most brokers will have enough selection to keep most people satisfied, though, especially in the higher-quality issues.

"Specifying the price you want to pay and waiting" might not be such a good thing. This is somewhat like market timing: nobody can tell you what direction prices are going to move, and you may be better off just paying today's price instead of hoping for something better. Limit orders might still be useful, though, if only to avoid wide price fluctuations in a volatile market.

Treasury Direct is great for a small portfolio: certainly, you will get a lower yield because you are limited to Treasury issues. But you might wind up with more money in the end, simply by not having to pay a broker's commissions and markups. Such costs at ordinary brokers can be relatively large, if one is not investing a lot of money.

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Author: KenAtPcs Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 4775 of 35392
Subject: Re: Understanding Mark Ups Date: 10/6/2002 1:50 PM
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Some brokers will charge an explicit commission, in addition to the hidden markup.

This has been my experience as well. I was surprised to read in William Bernstein's The Four Pillars of Investing that this is illegal! From the bottom of page 195:
"Although illegal, the charging of a commission on a principal transaction -- 'double dipping' -- is not a rare occurrence."

Gee, and I so thought brokers could be trusted. ;-)

Ken

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Author: imcharliehm Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 4776 of 35392
Subject: Re: Understanding Mark Ups Date: 10/6/2002 2:10 PM
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Today, with online bond quotes and trading, you can often find both the bid and ask prices instantly.

Make that "occasionally one can find the bid/ask" has been my experience. The spread is a function of supply/demand, with illiquid issues regularly having a 5-6 point spread at E*Trade and I've seen as wide as 11 with true junk. With listed bonds, the spread narrows to 2-3 points, but never, ever the mere pennies of the stock market.

On using limit orders, I'd made two (possibly conflicting) comments:

#1 If you shave the spread and get a fill, that's generally bad. The desk was dumping.
#2 In this market, limit orders are worthless. The desk is going to laugh at you and tell you the price is firm.

On the cost of doing bond transactions, several different things have to distinguished: volume discounts (you'll get a better price buying 100 than 5); the market maker's cut (the bid/ask spread); the broker's commission (typically $3-5/bond with a minumum of $40-50/ticket) Where things get obscured is when the broker is principal and bundles all three elements.

Bottom line? Bonds are a private club and retail investors are always going to get gouged by the gatekeepers, but even more so in these days of low interest rates. Only when the stock market is roaring and bonds are a despised asset class can you get something approaching fair prices.

Charlie

An aside: "Specifying the price you want to pay and waiting" might not be such a good thing. This is somewhat like market timing:

What is with you people and your pronounced adversions to market timing? Any buy/sell decision is a timing decision. If you can't do the trade at a price that is favorable to you, often it is better to back away and wait for the next opportunity.




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Author: opentolearn Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 4778 of 35392
Subject: Re: Understanding Mark Ups Date: 10/6/2002 7:11 PM
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Just wanted to thank all of you who responded. I was told Bonds are easier than stocks, but I am sure finding them confusing, especially the commossion, and your answers validated me. Thanks again.

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Author: foobar73 Big red star, 1000 posts Feste Award Nominee! Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 4780 of 35392
Subject: Re: Understanding Mark Ups Date: 10/6/2002 8:30 PM
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Today, with online bond quotes and trading, you can often find both the bid and ask prices instantly.

Make that "occasionally one can find the bid/ask" has been my experience. The spread is a function of supply/demand, with illiquid issues regularly having a 5-6 point spread at E*Trade and I've seen as wide as 11 with true junk. With listed bonds, the spread narrows to 2-3 points, but never, ever the mere pennies of the stock market.


I'm not saying one will like what one sees as the bid/ask prices. I'm saying one can usually find what these prices are, relatively quickly, using today's online systems.

What is with you people and your pronounced adversions to market timing? Any buy/sell decision is a timing decision. If you can't do the trade at a price that is favorable to you, often it is better to back away and wait for the next opportunity.

Because, on a day-to-day basis, one is going to be wrong just as often as one is going to be right, on average. For every winner in a transaction, there is a loser, and for every timing genius, there is a timing idiot. It's a mathematical certainty that not everyone will be better than average.

If you feel that the markets don't offer enough risk as it is, then you can certainly try your luck, and attempt to fall in among those people who are above average rather than below. Most people, however, would be better served by reducing their exposure to risk, by laddering bonds and dollar cost averaging, instead of timing.

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Author: imcharliehm Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 4781 of 35392
Subject: Re: Understanding Mark Ups Date: 10/6/2002 8:57 PM
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Whoa, opentolearn. Don't go quitting us before you've even gotten started. Or if you do want to quit already, you need to change your handle.

Bonds ARE easier than stocks. Certainly they are easier to spell, for being only five letters long instead of six. :-/

Seriously. Bonds CAN BE easy, just as stocks can be easy. Using Treasury Direct is about as simple as investments can get. But playing corporates in the secondary market is probably comparable to playing the pennies, which I would have to assume you would agree isn't easy, but they are stocks, just as much as the big cap stuff that are the media darlings.

And by stocks do you mean closing your eyes, throwing a dart, and then holding forever, or do you mean grinding through the 10Q's/10K's and winnowing industry sub-sector after industry sub-sector to find something decent you would like to own? Or do you mean sitting in front of a multi-monitor display, your trading platform running on one screen, the SOOZ in another window, 1 and 5 minute charts in other windows?

What you should be saying and realizing is that right now bonds aren't easy because of where we are in the interest rate cycle, just as stocks aren't easy because of the unwinding of the speculative bubble and the uncertainites over Bush's war. But now is also a good time to start learning the bond market from the sidelines, so that when things do get easy again, as they will, you'll be ready to participate knowlegibly and profitably.

Lastly, I would make a huge distiction bewteen "easy" and "fun". If it's easy you want, then there's probably no money in it, no matter the asset class. But if doing it ain't fun -- whether that "it" be investing , trading, or speculating --then it's also probably not worth doing at all. A lot of the people who hang out here invest in bonds because they have to. But a lot of us invest in them because we find the asset class and the investing challenges interesting.

That's the challenge you should put to yourself: Are bonds an asset class you want to learn? If the desire is there, so will become the means.

Charlie

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Author: opentolearn Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 4782 of 35392
Subject: Re: Understanding Mark Ups Date: 10/6/2002 9:52 PM
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Hi Charlie:

I'm not leaving. I love learning, only I get impatient and overwhelmed. I belong to N.A.I.C. and have been learning about stocks for a few years now, and have made some horrible mistakes, as well as some okay decisions. The more I learn the less I know.

I bought some I bonds a couple of years ago and some treasuries direct. I am that certain age where I have to be careful, so income is one consideration, but definitely not the only factor. I presently have a portfolio with a so called friend who has an agency that specializes in bonds. I just left it to him, and have been disappointed and realize I can't leave it to anyone, I have to know what I am doing, so I am thinking of taking it away from him and putting it in a couple of brokerages (either on line, or in person). There would be stocks in my portfolio too. I would not be trading bonds, I just need to have more conservative investments. I have quite a bit of cash in short term treasuries until I decide what to do, that was why I was asking my questions.

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Author: imcharliehm Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 4783 of 35392
Subject: Re: Understanding Mark Ups Date: 10/6/2002 10:45 PM
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Opentolearn,

If you've been doing the NAIC gig, you're in good shape to do bonds, with very little extra to learn, because financial ratios and statements will already be familiar to you. Stocks or bonds, in both cases you're just investing in the underlying company and the numbers have the same impact. The main difference is your position in the credit line and the fact that bonds do mature.

A suggestion. Go back and read everything Chris (aka, Crosenfield) has posted. She's as level-headed and experienced a fixed-income investor as they come.

Some additional reading you might do: This week's Business Week Magaazine has a good article on identifying debt in financial statements in their The Fine Print series, and is generally a good source of what's happening. Also get a hold of Marty Whitman's book <Value Investing: a Balance Approach, as well as go to the Third Avenue website and go thorough his letters to shareholders. He is one of the best at being able to decide whether to be an owner or a creditor. Get a hold of Fridson's book Financial Statement Analysis" for a look behind the scenes of financial statements. Get a hold of Barnhill's book High Yield Bonds, not because you want to invest in them (yet), but because the book is really good about explaining how the bond market really works.

Best wishes, Charlie

PS No, I don't trade bonds either, as very few of us on this board do, because transaction costs are prohibitive and the necessary data is all but impossible to obtain.

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