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Author: JoelKrug Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35252  
Subject: Re: Bonds Date: 11/21/2001 8:26 PM
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While I don't disagree, I think that the issue of "premium" vs. "discount" is really a red herring ... IF you focus on the proper yield measures when you buy. I'm no expert ... not by a long shot ... so please correct me if I've made a mistake or oversimplified, or please forgive my naivete if it shows too conspicuously!

Here's my reading:

* When you buy a bond you need to look at the YIELD TO MATURITY (YTM) and the YIELD(S) TO CALL (YTC), and not simply the coupon or current yield or price. (Of course, you should also examine various other - and critically important - characteristics, such as rating, maturity date, tax status, etc.)

* If you're holding to maturity, and the bond is non-callable, the YTM takes into account the "premium" or "discount" (viz., it is based upon the current price, coupon and the maturity date). So there's no real "loss" at maturity ... you make a profit with an annualized equivalent return of the YTM. (In fact, if you buy at a premium, I presume there's a nominal capital loss at redemption, offsetting some of the taxes paid on distributions.)

* If the bond is callable ... you need to look at the string of call dates and prices and the associated YTCs. Same logic as above, though --- the difference being that the bond may be called, e.g. at the date corresponding to the lowest YTC. The callability of the bond clearly introduces some added risk ... which SHOULD get reflected in a slightly higher yield than a non-callable bond with otherwise identical characteristics.

* If you don't hold to maturity, the price will go up or down with the usual factors (interest rates, changes in bond quality, other market conditions) ... but this is pretty much the same whether you paid a premium or a discount, so far as I can tell.

Again, my apologies if this list is either naive, misleading or wrong ... but I'd sure appreciate help if it is any of the above! I simply don't see why "premium" or "discount" matters!!

... Joel
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